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December 18, 2023 | read

Tax and Accounting Tips for Real Estate Syndicates

Brandon Hall


Are you syndicating real estate deals? If one of your prospective investors came up to you and asked how you plan to mitigate the Business Interest Limitations, would you be able to answer them confidently?

Real estate investors who are new to syndicating large, multi-family properties tend to make mistakes on their first few deals. Sometimes these mistakes can tie them up in litigation and ruin their reputation permanently. This article will give you the tax, accounting, and general business tips necessary to ensure your syndication runs smoothly.

Tax Tips

New real estate syndications experience the same tax issues. We know because we have helped hundreds of general partners through their first few deals.

This section provides you with three high-level tax tips to use for your syndicated real estate deals to better optimize for taxes. These are: developing a general tax plan, using cost segregation, and the business interest limitations.

The first tip is to always have a tax plan. I know that sounds silly, but we work with many syndicates that come to us after they have purchased their deals and they don’t have a clue as to what they need to do with their taxes. So, the very first thing to do is to get with a CPA and make sure that you have a tax plan in place so that you can talk to your investors about exactly what you’re going to do mitigate their tax bills.

The second tip is to use cost segregation studies. A cost segregation study is the practice of assigning value to all of the property’s components. Generally speaking, when you buy a property, you depreciate it all over 27 and a half years (residential) or 39 years (commercial). That’s a long time to recover the cost of some of the components of the property that are going to wear out way before 27 and a half years or 39 years. A cost segregation study takes some of that purchase price and allocates it to five year, seven year and 15 year property. Five year property is personal property and 15 year property is land improvements. After that allocation is done, you depreciate the respective components of your property over those time frames.

In the first five years after you have a cost segregation study performed, your depreciation annually is way higher than it would have been had you just depreciated everything over 27 and a half years. There’s one big added benefit for cost segregation studies, thanks to the 2017 Tax Cuts and Jobs Act, and that’s 100% Bonus Depreciation on any component with a useful life of less than 20 years. So, if the point of a cost segregation study is to identify and assign value to five year, seven year, and 15 year property, then you can use 100% Bonus Depreciation in the very first year to immediately write off all property with a useful life of less than 20 years. You can see that a cost segregation study can be extremely valuable for any multi-family syndicate.

The third tip is to have a plan for the Business Interest Limitations. If you’re a standard syndicate, more than 35% of your entity is likely owned by limited partners. In any year that you have passive losses, you’re going to be considered a tax shelter, which will automatically make you subject to the Business Interest Limitations. The Business Interest Limitations significantly limit what you can deduct from your mortgage interest. It’s a really good idea to have a plan in place to mitigate the potential downsides of the Business Interest Limitations.

Accounting Tips

Deal sponsors of real estate syndications have a lot on their plate. There are so many tasks pulling you in multiple directions at once. But when you’re managing other people’s money, you really need to focus on having a solid accounting system in place. These tips will help you improve your accounting system to better manage your investors’ money.

The first tip is that you really need more than bookkeeping. Yeah, your property manager can do the bookkeeping for you, and that’s fine, but either you or a CPA needs to consolidate what the property manager is doing with the entity-level transactions. The property manager’s only going to capture the property level transactions, so you need somebody capturing the entity level transactions and focusing on producing solid reports to investors.

The second tip is to use accounting software to automate the majority of your accounting and produce professional looking reports. We’ve helped syndicates who are recording their entries on spreadsheets or Google Sheets. That’s not a good accounting system. Things will be missed and it’s very difficult to reconcile to the bank statements. Using professional grade accounting software will allow you to automatically reconcile the bank statements, and ultimately reduce your overall workload. One thing that accounting software does really well is produce professional reports. You can cut up the reports to show investors whatever you need to show them or whatever they request. We recommend using Quickbooks Online or Xero for professional level accounting software.

The third tip is to create a cash flow budget and update it frequently. This is different than the operating budget that you do with your property manager or your lender. What I’m talking about is something that you can refer to to understand how your cash flow’s going be impacted with various CapEx items, reimbursements from the lender, and distributions to investors. One of the hardest things that we see the general partners we work with go through is understanding how to manage their cash. Often, they don’t even know how much they can distribute to investors on a quarterly basis, so having some sort of cash flow budget tool that you can refer to and update frequently will really help you with transparency and help you make better decisions in terms of distributions.

The fourth tip is: don’t commingle any funds! It’s so important to not transfer funds from one deal to another deal or into your personal bank account. The only times that funds should be leaving the entity is for investor distributions or for your asset management fees.

The fifth tip is to have a capitalization policy and share it with your investors. A capitalization policy is something that an entity creates. It helps you understand what to write off and what to capitalize on the balance sheet. Capitalization policies are one of the most overlooked tools for new real estate syndications that can save you a lot of headache later on when you’re communicating to your investors. Think of it like this: let’s say that you had a capitalization policy of $500. That means that every expense that’s over $500, you’re automatically putting on the balance sheet. So if I have a $1,000 repair, but my capitalization policy says $500, I’m putting that $1,000 repair on the balance sheet. It’s not going to be a current expense on my profit and loss statement. At the end of the day, that inflates my net profit, and allows me to show investors that I’m performing way better than I actually am. That’s only because that expense is not on the profit and loss statement, it’s on the balance sheet. We typically recommend a capitalization policy equal to the De Minimis Safe Harbor of $2,500 or something like $5,000, but it’s really up to you. Share it with investors so that they understand how to interpret the financial statements that you’re giving them, and so that they don’t question you when you’re midway through a deal.

General Business Tips

The first tip is to always review your loan documents for your financial reporting requirements. Often, when we’re talking to general partners in new syndications, we find that they haven’t adequately reviewed the financial reporting requirements for the loan that they just signed. Typically, they buy the property, and then a couple of months in they start to figure out what exactly they need to be producing and sending to the lender every single month. The lender will typically say something along the lines of, “I just need a profit and loss statement, a balance sheet, a statement of cash flows, and a rent roll.” That’s what’s being sent to the lender on a monthly basis. But, we often find that the mortgage documents, the actual loan documents that were signed before closing, require a lot more financial reports to be sent to the lender on an ongoing basis. One simple way to avoid your mortgage going into default is to know exactly what is required by the lender. If the lender’s requiring some crazy statements on a monthly or annual basis, give them a call, follow up in an email to get it in writing, and try to talk them down on how much reporting you have to give them on an ongoing basis.

The second tip is to communicate proactively to your investors. So, things go wrong and that’s okay. But it’s not okay if you don’t let your investors know in a timely manner. You should always keep your investors front of mind. After all, they’re the ones that have entrusted you with 50, 100, 400, however many thousands of dollars. So, keep them front of mind whenever something goes wrong. Get in front of your problems and let the investors know when issues are coming up. It’s okay if this syndication does not play out according to plan as long as you are communicating proactively to your investors and keeping them in the loop.

The third tip is to have a plan for your first investor distribution. We often see syndicates withhold that first distribution so that they can build a cash reserve, to help better manage cash flow. And that may work for some syndications. It may or may not work for you. The idea is to go into that first deal having a plan in place, so that again, going back to tip number two, you can proactively communicate your plan to your investors.