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.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
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.
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
Dwight Kay is the Founder and CEO of Kay Properties and Investments LLC. Kay Properties is a national 1031 exchange investment firm specializing in Delaware statutory trusts. The www.kpi1031.com platform provides access to the marketplace of typically 20-40 DSTs from over 25 different sponsor companies. Kay Properties team members collectively have over 340 years of real estate experience, have participated in over $39 billion of DST 1031 investments, and have helped over 2,270 investors purchase more than 9,100 DST investments nationwide.
-
Stock Market Today: Nasdaq Soars Ahead of Tesla Earnings
The EV stock rose nearly 2% ahead of its highly anticipated Q1 earnings report, due after tonight's close.
By Karee Venema Published
-
GM Stock Accelerates After Earnings Beat
General Motors beat expectations for the first quarter and raised its outlook for the year. Here's what you need to know.
By Joey Solitro Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
Pros and Cons of Waiting Until 70 to Claim Social Security
Waiting until 70 to file for Social Security benefits comes with a higher check, but there could be financial consequences to consider for you and your family.
By Patrick M. Simasko, J.D. Published
-
Now Could Be Time for Private Investors to Make Their Mark
The venture capital crunch may be easing, but it isn't over yet. That means there could be direct investment opportunities for private deal investors.
By Thomas Ruggie, ChFC®, CFP® Published
-
How to Stop Boredom From Ruining Your Happy Retirement
Retirees who explore new interests and have an active social life are more likely to find joy — and even greatness — in the newfound freedom of retirement.
By Richard P. Himmer, PhD Published
-
The Life-or-Death Answers We Owe Our Loved Ones
How our life ends isn’t always up to us, but that question too often must be answered by loved ones and health care workers who don’t know what we would want.
By Joel Theisen, RN Published
-
Hot Tips for Home Buyers and Sellers Right Now
Real estate looks to be especially hopping this spring, thanks to pent-up demand and buyers adjusting to higher mortgage rates. Here’s how you can prepare.
By Pam Krueger Published
-
Is 100 the New 70?
Eating well, exercising, getting plenty of sleep and managing chronic stress can help make you a SuperAger. Funding that long life requires longevity literacy.
By Phil Wright, Certified Fund Specialist Published
-
Nine Lessons to Be Learned From the Hilton Family Trust Contest
Disclaimers, good communication, post-marital agreements and more could help avoid conflict in a family after the owners of a wealthy estate pass away.
By John M. Goralka Published