real estate investing

Before You Invest in ‘Crowdfunded’ Real Estate, Consider the Tax Implications

Many syndicated real estate investments miss out on a major tax benefit, but there are some ways to do your deal that avoid that issue.

The rise in online real estate investing in recent years has been remarkable. As the global consulting firm EY estimates, the online real estate investing market worldwide is expected to be $8.3 billion in 2020, with no sign of slowing.

For all the benefits of joining the crowd, there is one downside to many syndicated investments that every real estate investor should know. Most co-investment opportunities are in the form of limited partnerships (LPs) or limited liability companies (LLCs). That’s not necessarily bad, except that those forms of syndicated ownership do not qualify for one of the most advantageous real estate tax benefits available in the U.S.: 1031 exchanges.

Also known as like-kind exchanges, 1031 exchanges allow investors to defer taxes on capital gains at the time real property investments are sold if the net equity is reinvested into a similar investment property of the same or greater value. With a 1031 exchange, an apartment building can be exchanged for a warehouse, a warehouse for a piece of raw land, a piece of raw land for a single-family rental property, etc.

The net effect of 1031 exchange investing: The initial invested capital and the gain can continue to grow, potentially, without immediate tax consequences. Then, if and when the new investment is sold without the equity reinvested in another exchange property, the prior gain would be recognized. There are some finer points, and investors should consult their tax or legal advisers prior to selling or exchanging a property, as everyone's tax situation is different.

A Hypothetical Example

If an investor places $100,000 of capital into a crowdfunded LLC offering that is purchasing an apartment building, and the property sells after a few years and has a gain, the investor will be subject to depreciation recapture tax of 25%, federal capital gains tax of 15%-20% (depending on their income tax bracket), state capital gains tax of 0%-13.3% (depending on the investor’s home state) and an additional 3.8% Medicare surtax.  All told, the gain from the crowdfunded investment may be subject to taxation of 20%-45%+, leaving the investor with far fewer investment dollars to reinvest.

However, if that investor had participated in a 1031 exchange program with the $100,000 investment, he or she would be able to defer 100% of the potential gain and depreciation recapture coming out of the sale, thus keeping more of their capital invested in real estate to generate potential cash flow and appreciation versus paying a large tax bill.

To be clear: A 1031 exchange allows the participating investor to defer federal and state capital gains taxes, as well as other taxes. It’s a potentially big tax benefit, depending on your individual situation, which is why approximately one-third of all income property sales in the U.S. involve a 1031 exchange.

2 Ways to Pool Your Money and Still Qualify for a 1031 Exchange

But if most crowdfunded investments don’t qualify for 1031-exchange treatment, which assets do? The IRS identifies two types of co-ownership structures that are allowable for 1031 exchanges: Delaware Statutory Trusts (DSTs) and Tenants-in-Common (TIC) investments.

DSTs and TICs have been around since the early 2000s and have demonstrated their efficacy as direct real estate ownership vehicles. Most types of real estate can be owned in a DST, including retail, office and multifamily properties, and, notably, a single DST can own multiple properties, serving as a diversification vehicle. Mountain Dell Consulting reports that investment in DSTs and TICs reached a post-recession high in 2019, and the trend continues.

As you consider the wide range of online real estate investment opportunities, keep in mind that not all investments are created equal, since with a typical LLC or LP offering when the property is sold investors will not be able to participate in a 1031 exchange and thus will be hit with a tax bill.

About the Author

Dwight Kay

Founder and CEO, Kay Properties and Investments, LLC

Dwight Kay is the Founder and CEO of Kay Properties and Investments, LLC.Kay Properties is a national 1031 exchange investment firm. The www.kpi1031.com platform provides access to the marketplace of 1031 exchange properties, custom 1031 exchange properties only available to Kay clients, independent advice on sponsor companies, full due diligence and vetting on each 1031 exchange offering (typically 20-40 offerings) and a 1031 secondary market. 

 

https://brokercheck.finra.org/firm/summary/152550

Most Popular

13 States That Tax Social Security Benefits
social security

13 States That Tax Social Security Benefits

You may have dreamed of a tax-free retirement, but if you live in these 13 states, your Social Security benefits are subject to a state tax. That's on…
October 21, 2020
How to Be Happy (Not Bored!) in Retirement – Starting Today
happy retirement

How to Be Happy (Not Bored!) in Retirement – Starting Today

Here are 12 ways to prepare now for retirement so that you’ll be happy, active, fulfilled and never, ever bored.
October 21, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy still in trouble, tax policy takes on added importance in the 2020 election. So, let's take a look at what Joe Biden wants to do abou…
October 22, 2020

Recommended

Know What You’re Paying for When You Buy an Annuity
annuities

Know What You’re Paying for When You Buy an Annuity

Demystifying annuities is important now more than ever as the current market landscape is shining a light on the benefits an annuity can provide. A fi…
October 24, 2020
The Politics of Election-Year Financial Planning
retirement

The Politics of Election-Year Financial Planning

The competing candidates for president are polar opposites in terms of taxes, adding a new urgency to year-end tax planning. Just what are they propos…
October 24, 2020
Know What You’re Getting – and Giving Up – With an Annuity Income Rider
annuities

Know What You’re Getting – and Giving Up – With an Annuity Income Rider

Guaranteed income is always nice, but nothing in life is free. Weigh the trade-offs carefully.
October 23, 2020
Why Are Roth Conversions So Trendy Right Now? The Case FOR and AGAINST Them
Roth IRAs

Why Are Roth Conversions So Trendy Right Now? The Case FOR and AGAINST Them

Have you been tempted to join the wave of folks jumping on the Roth IRA conversion bandwagon? First, check out the pros and cons to see if it makes se…
October 23, 2020