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Its common to ask for opinions before investing in a real estate syndication. You might speak to your spouse, members of your real estate circle, previous investors of the management team, and maybe your financial advisor. But what about your CPA?
Syndications can be a powerful tax planning tool, but can also have negative tax consequences if you're not careful. Below are some important questions to ask your CPA before investing in a syndication.
Do you have other clients that invest in syndications?
This should be the first question you ask your CPA. Followed by, do you invest in syndications?
Think about it, if your CPA doesn't have any clients that invest in syndications, or invest themselves, how can they properly advise you?
However, if your CPA has a lot of clients that invest in syndications and/or invest themselves, they understand what to look for in a good investment, and what to avoid.
They can see eye-to-eye with you and better understand how a syndication will fit into your overall tax and investment plans. Whereas a CPA who doesn't have any experience with syndications may not have a clue on how to properly advise you.
Will I be subject to UBIT?
If you make the investment using a Self-Directed IRA (SDIRA), your investment returns are not always tax-free. A portion of that income may be subject to the Unrelated Business Income Tax (UBIT).
UBIT is generated by Unrelated Debt-Financed Income, which is the portion of a property's income generated by debt financing. This portion will be subject to the trust tax rates, which scale quickly to 37%, after just $12,501 of UDFI.
If your investment is large enough, this tax may eat into your investment returns.
Can I invest in a syndication using a 1031 Exchange?
Do you have a rental property that you're looking to sell using 1031 exchange?
There is a common misconception that you can simply 1031 directly into a syndication. However, this is not possible because when you invest in a syndication, you are purchasing part of an entity that owns real estate, and not the real estate itself.
However, you can use a 1031 exchange to invest in a syndication-type opportunity using a tenant in common (TIC) structure or Delaware Statutory Trust (DST). While these options are similar to syndications, they are not syndications.
So if you are planning to use a 1031 exchange to invest in a "syndication", you want to talk with your CPA to ensure what you're investing in is really a TIC or DST, and not a traditional syndication. Otherwise, you'll be stuck paying the capital gains tax you thought you dodged.
How can I use my passive activity losses to my advantage?
Another common misconception among passive real estate investors is that you can use the passive losses from a syndication to offset your active (aka ordinary) income.
For accredited investors, these losses do not offset your active income, even if you're a real estate professional for tax purposes. However, they may offset active income after the property is sold.
This creates an interesting tax planning opportunity if you have passive activity income from other sources. Or can invest in other passive investments that generate passive activity income. Passive activity income can come from rental real estate, oil & gas investments, and limited partnerships (i.e. investing in small businesses as a silent partner).
Will the business interest limits affect me?
The Tax Cuts and Jobs Act introduced business interest limits. And they apply to entities that allocate 35% or more of their passive activity losses to limited partners. Which is the case for most syndications.
This change limits the mortgage interest deduction to 30% of adjusted taxable income. But syndicators can elect out of this limit by electing to be a real estate trade or business for tax purposes. The downside of this is real property then has to follow a longer depreciation schedule. And may not be eligible for 100% bonus or accelerated depreciation on property with useful lives of 5,7, or 15 years.
And since there are still a lot of unknowns about these limits. You should ask CPA before investing to see how this will affect you. Especially if you plan to use passive activity losses generated by the syndication to shelter passive activity income.
The Bottom Line
Not all syndication opportunities are created equal. And choosing the right syndication opportunity will depend on your investment goals and personal tax situation.
So before you invest in your next syndication, run it by a CPA first.