Revisiting The Tax Benefits of Investing In Real Estate

Feb 1, 2023 | Educational Guides, Industry Articles

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Enhancing Investor Experience: Our Commitment in Real Estate Investment

When it comes to managing our Investor experience, we have two Golden Rules at Wildhorn Capital.  These are non-negotiables that are ingrained in our DNA. First, we’re going to send out an update on every project every month without fail.  Investors will never have to wonder what’s happening on the projects for which they are invested with us.  Second, we’re going to get our K1’s sent out on time.  No one is going to have to file an extension because of us.

Eliminating Stress in Real Estate Investment: Timely Updates and Reliable K1 Deliveries

As passive investors ourselves, nothing is more infuriating than not getting timely updates from the sponsors and teams in which we’ve invested.  Or wondering if and when we might get our K1’s.  Our CPA starts calling us, asking when we’ll get them.  We start pinging the sponsor.  It just creates unnecessary stress and complications that no one wants–or needs. 

How Real Estate Investment Offers More Than Projected Returns

In order for us to meet our deadline of getting K1’s delivered to Investors in early March, our prep work starts as soon as we get back from the New Year.  December and year-end financials are finalized by the onsite team the first week of January.  Our internal accounting team reviews and blesses them, and everything is packaged up and sent to our Tax Accounting firm.  

Sitting here in late January, we’ve just finished up the bulk of our review and our Tax team is getting started on their side.  As we sat and reviewed our financials, it dawned on me that this would be a pretty good time to review the many benefits of passively investing in a real estate asset.  All too often it seems like the focus of many Investment Memorandum’s we see (ours included) are focused on the projected returns of that investment.  Rightfully so. 

The Unnoticed Tax Benefits of Investing in Multifamily Assets

But those projections don’t tell the full story on the power of investing in real estate.  And don’t accurately reflect the tax-adjusted returns investors may realize.  Not every 15% IRR you see is created equal. 

In today’s article, we wanted to revisit and highlight some of the tax benefits of investing in multifamily assets. Of course we aren’t tax professionals and everyone’s personal situation is unique and different, but the below items are benefits not typically factored into the returns you see touted on Investment Summaries.  (We’re also not attorneys, but they would encourage us to add a statement about how we are not providing any sort of tax or legal advice and you should consult your own advisors before making an investment decision.)


The Big Tax Advantages When Investing in Real Estate

The big tax benefits of Investing in Real Estate–as we see them: 

Depreciation + Cost Segregation: For many, depreciation is the most impactful tax benefit from investing in real estate syndications. The IRS acknowledges that buildings deteriorate over time, and therefore allows property owners to write off the wear and tear over the lifespan of the property: 27.5 years for residential and 39 years for warehouse/commercial. 

This deduction allows you to report a smaller profit to the IRS, thereby reducing the amount you ultimately owe in taxes. In this way, you can greatly offset the gains from your investment.

In the world of commercial real estate, we also have another great tool to help accelerate that depreciation–Cost Segregation. Cost segregation is a strategic tax planning tool that we do on all of our assets and projects. A firm is hired to identify all of the property-related costs that can be depreciated over 5, 7, and 15 years rather than 39 years. . 

This typically yields more significant depreciation deductions in the early years of owning the asset. The accelerated depreciation deductions and deferred income taxes, allows companies, individuals, and accredited investors to enhance their positive cash flow.

Depreciation Recapture: At the time the investment property is sold, you will be required to account for the deductions previously taken. Yet the rate is limited to 25 percent, which is considerably better than the top income tax bracket. In addition, you have successfully deferred tax payments for a number of years.

Income Tax vs. Capital Gains: As you likely know, capital gains are the profits from selling a property and will be taxed.

Fortunately, the capital gains tax rate is lower than the rate for traditional income. And when real estate is held more than a year, the profits from a sale are considered long-term capital gains as opposed to short-term capital gains.

This income will be capped at a 20% tax rate, which in comparison, is far better than 32% – 37% you might be paying on W2 income. That is why the income you create from investing in real estate is more tax efficient than income from a day job.

Mortgage Interest Deductions: Investors may deduct money paid as mortgage interest during the tax year from their taxable income. 

As with a deduction for depreciation, mortgage interest deductions are a tool for investors in real estate syndications. Investors can deduct the interest on a mortgage loan as a line item expense on the income statement. 

Opportunity to 1031 Exchange:  Via Section 1031, the equity from a sold real estate asset can be reinvested into an equal or greater valued commercial real estate asset and associated gains can be deferred. By reinvesting the value from the property and purchasing a new commercial real estate asset, the value is transferred (a like-kind exchange) into the new property and is not recognized as a taxable event.

The main benefit of carrying out a 1031 exchange rather than simply selling one property and buying another is the tax deferral. That is why we always strive to do a 1031 exchange – it frees up more capital for investment and increases investors’ returns. This helps us keep the money working for you, rather than paying out about a third of that equity in taxes.

All of these deductions and benefits add up.  They may actually end up showing as a net loss on paper for your investment. This can be a great thing because all the distributions you receive could be tax-free. If the losses exceed your gains, then you can carry those losses forward to offset other passive income.

While the tax code is changing all the time–Bonus Depreciation, Opportunity Zones, etc–it’s critical that all investors (us included) stay on top of the current policies and regulations. Our Tax firm does a great job of helping advise us on that front as we look for the most advantageous structures and strategies to take advantage of. 

We’re no tax experts.  But we do know investing in real estate has serious tax advantages relative to other investment classes and it’s always something to be thinking about.  Especially as we enter tax season and focus on getting hundreds of K1’s prepared for our investors.

Andrew Campbell

Written by Andrew Campbell

Andrew Campbell is a native Austinite and Managing Partner at Wildhorn. He is a real estate entrepreneur who first broke into the business in 2008 as a passive investor. In 2010 he transitioned into active investing and management of a personal portfolio that grew to 76 units across Austin and San Antonio. He earned his stripes building and managing his personal portfolio before founding Wildhorn Capital and focusing on larger multifamily buildings. At Wildhorn, he is focused on Acquisitions and maintaining Investor Relations, utilizing his marketing and communications background to build long-term relationships.

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