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What Are the Tax Implications for General Partners (GPs) of Real Estate Syndications?

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    As a General Partner (GP) in a syndication, you receive multiple streams of income. The question then becomes, how are these different streams of income taxed? And what can be done to mitigate these taxes? Well, in this post we'll discuss just that!

    As a preface, syndications are generally taxed as partnerships, and partnerships are not taxed at the partnership level. Instead, each partner receives their share of income/losses on Form K-1, which is filed on their individual tax return.

    Fees

    As a GP in a real estate syndication, you're responsible for identifying the property, obtaining both equity and debt financing, putting together a management team, managing the property after its acquired, and later selling the property. All this is done on behalf of your investors, the limited partners (LPs).

    For your efforts, you're rewarded with various fees which generally include:

    • Acquisition Fee (1-3% of purchase price)
    • Asset Management Fee (1-2% of gross monthly collected rents)
    • Construction Fee
    • Refinance Fee
    • Disposition Fee

    Acquisition and Asset Management fees are the most common fees you'll receive in a syndication. However, any of these fees you receive will be taxed as ordinary income and subject to the self-employment tax of 15.3%.

    One strategy to mitigate some of the self-employment tax is to receive these fees through an LLC taxed as an S-Corp. An S-Corp allows you to classify part of your income as wages and the rest as dividends. Only the wages are subject to the self-employment tax.

    Example:

    You're syndicating a 100 unit apartment building with an acquisition price of $4.8 million. For your efforts, your investors agree to an acquisition fee of 1.5% of the purchase price. And a 1% asset management fee on gross collected rents, which are projected to be $960,000/year.

    The acquisition fee of $72,000 (1.5% x $4.8 million) and annual asset management fees of $9,600 (1% x $960,000) are taxed as ordinary income and subject to the 15.3% self-employment tax. Let's say you're in the 32% federal tax bracket, you're tax will be $26,122 ($81,600 x 32%) plus $12,485 ($81,600 x 15.3%) in SE tax. That's a total of $38,596 in taxes in the year you acquire the property.

    To mitigate the SE tax, your CPA helps you set up an S-Corp to receive the fees. And determines that $30,000 is a reasonable salary for your efforts. Now only the $30,000 wage is subject to the 15.3 SE tax, which saves you $7,895 in taxes ($12,485 - $4,590).

    Cash Flow and Sales Proceeds

    In addition to fees, you also receive an equity interest in the deal. This allows you to receive a portion of the cash flow (rental income) from the property, and a portion of the proceeds upon sale.

    With the help of your CPA and attorney, you structure the syndication in a way that classifies your portion of the sales proceeds as capital gains, rather than ordinary income. This is an important distinction because capital gains are taxed at 15-20% while ordinary income can be taxed as high as 37%. Note if your MAGI is above certain thresholds, you will be subject to an additional tax called the Net Investment Income Tax (NIIT) of 3.8%.

    The rental income/losses are treated as they would in any other rental property. If you have net income it will be taxed as ordinary income. If you have a net loss, it can be used to offset passive income from other properties. Otherwise, it will be suspended and carried forward into the future, unless you're considered a real estate professional for tax purposes.

    Also, when the property is sold, you'll pay depreciation recapture tax (up to 25%) on the portion of the gain that is created by the depreciation taken over the years of ownership.

    Example

    In addition to fees, you also receive a 20% equity stake in the property. Which allows you to collect 20% of the cash flow and sales proceeds when the property is sold.

    In the first few years of the investment, a loss is produced for tax purposes. Since you're a real estate professional, this loss offsets your ordinary income, which can include fees. In the event you're not a real estate professional, these losses will offset other passive income or be suspended and carried forward to future years.

    Should the investment show net income, it will be taxed as ordinary income (i.e. 32%), plus the 3.8% NIIT.

    Over the five years you hold the property, it appreciates from $4.8 million to $6.2 million and accumulates $698,182 in depreciation. This produces a total gain of $2,098,182. Of this gain, $698,182 is subject to depreciation recapture and the remaining $1.4 million is considered a long-term capital gain.

    Because you have a 20% stake in the property, your share of this gain is $419,636. $139,636 (20% x $698,182) is subject to depreciation recapture and the remaining $280,000 is considered a long-term capital gain. You will pay $34,909 (25% x $139,636) in depreciation recapture tax and $42,000 (15% x $280,000) in long-term capital gains tax. Also, because you're in the 32% tax bracket, you're going to pay an additional $15,946 in NIIT.

    The Bottom Line

    As a General Partner (GP) it is important to understand these different streams of income and their tax implications. That way you can take the necessary steps to mitigate these taxes where possible.

    Before you do your next syndication, ask your CPA what the tax implications will be for your specific circumstances. And what planning opportunities are available to help reduce the amount of taxes you'll have to pay.

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