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How to Legally Minimize Tax Payments




Taxes - What a buzzkill


Life, death, and.... We've all heard the saying. You work hard for your money. You've gone to school, gotten a good paying job, taken risks in debt and investments, only for Uncle Sam to take a chunk away of your profits. No one likes paying taxes, and the burden of taxes weighs heavily on most of us, sparking frustration and annoyance. As a high-income earner, there are strategic ways to invest, defer, eliminate, or pay less in taxes over time at lower tax rates than vs. your earned income tax rate.


In the words of Robert Kiyosaki: “It's not now much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.”


We believe Real Estate is one of the best tax havens. Let's explore some strategies that can be utilized through Passive Investments in Real Estate to keep your hard earned cash working for you, and eliminate the buzzkill of a hefty tax bill.


Disclaimer: We are not tax advisors. This communication is intended to convey general information only and is not intended or written by us to be used, and cannot be used, for the purpose of avoiding taxes or penalties that may be imposed by any governmental taxing authority or agency. Further, the information presented herein may not reflect the most current tax or legal developments. Please consult with your attorney, CPA, and other tax/legal professionals on advice on specific tax/legal issues.


IRS TAX CODES: We (De)preciate You Very Much!


One effective way to reduce tax obligations is through investments that offer tax write -offs. Luckily, the government offers substantial tax benefits in real estate because they want to keep the nation supplied with good housing, and so they provide tax relief for individuals who help them do just that in the form of depreciation. Thus, real estate is depreciable over a fixed amount of time (27.5 years, or 3.636% per year). These depreciations can minimize, eliminate, or defer tax bills over many years or decades, making real estate a favorable investment vehicle over the Stock Market for investors like us.

Long-Term Capital Gains Tax Rates as of 2023

Annual Income

Capital Gains Rate

$0 - 44,625

0%

$44,626 - $492,300

15%

$492,301+

20%

Both the stock market and Real Estate investments are subject to Capital Gains taxes, but real estate capital gains taxes can be offset by depreciation.



Depreciation 2.0


Before we look into a Passive Investment Tax Strategies, let's talk about more depreciation: Bonus Depreciation and Cost Segregation


  • Bonus Depreciation: The example above (a property depreciates at 3.636% for 27.5 years) is called straight line depreciation. As of 2017, the Congress passed a bonus depreciation law that allowed for Active investors to depreciate 100% of an asset (minus land value) in year 1 of ownership. The paper losses that creates can then be used to offset gains in future years. in 2023, bonus depreciation was reduced to 80% and it will remain on a 20% declining annual schedule until it is phased out in 2027 (i.e. 60% in 2024, 40% in 2025, etc.), or unless Congress extends the law beyond 2027.

  • Cost Segregation: Just as a building depreciates, the government says real property assets (appliances, light fixtures, door knobs, windows, etc..) can be reclassified as tangible personal property and depreciable as well. The difference in the depreciation between the reclassified personal property and the real property can provide significant tax savings.


Unfortunately, when investing passively in real estate as a LP, depreciation will only offset your passive income and not your earned income from your day job. Thus, you'll be subject to capital gains taxes included capital gains taxes on any depreciation recapture when the property sells. Now let's get to the juicy stuff...




TAX SAVINGS THROUGH PASSIVE REAL ESTATE INVESTMENTS


Strategy #1 - Reinvest & Defer


Your part of a real estate syndication and are enjoying the benefits of passive income. Now the property sells and you're hit with 15% capital gains taxes. Not bad, because you are a high income earner and 15% is still lower than your tax bracket. But, it gets better.


You can reinvest that passive income into another syndication within the same calendar year, and depreciation from the new property will offset any taxes owed from the liquidation of the first property. Not bad!



Strategy #2 - Become a Real Estate Professional


You are killing it at your job. You are a dentist, a doctor, engineer, tech professional etc... You don't have time to work full time in real estate. True, but we've come across many people in these fields who have spouses that work in Real Estate full time, and with a real estate designation and documented proof of real estate activities, that allows for depreciation benefits against earned income!


Even better, by the IRS defines a "full time" real estate agent as one who can log a minimum of 750 hours in real estate activities per year. That is only 14.5 hours per week!



Strategy #3 - Purchase or Own an Owner-Occupied building in a Separate LLC


Dentists, Doctors, this applies to you!


Per IRS Treasury Reg §1.469-4: "One or more trade or business activities or rental activities may be treated as a single activity if the activities constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469.”


Let's break this down. What this is saying is passive activities can be overcome by treating 2 entities (as S Corp and a LLC) as one economic unit for the benefit of making all income active.


Example: As a doctor you own a practice operating as an S-Corp and own the building you work out of under a LLC. Usually, the tax strategy is to have the LLC break even each year by paying the rent from the S Corp to cover all of the LLC's expenses. Electing to treat the 2 entities as one economic unit eliminates passive activity rules, allowing the LLC to take advantage of cost segregation & depreciation.



Bonus: Other Considerations


Investment properties offer a host of tax advantages, and here are some more ways to reduce your tax burden through real estate syndications & other investments.

  1. 401Ks and Self-Directed IRA: As with stocks, you can also invest in real estate syndications with a qualified retirement account. You'll want to convert your 401(k) or SDIRA with a qualified intermediary to do so. With an eQRP, you can defer up to $67,500 per year single or $135,000 married.

  2. LLC: Following SDIRA administration, you have another option: establish a legal entity and fund it with your SDIRA (Tax-Free). Subsequently, you can invest using your LLC. This strategy offers several benefits, including the ability to choose different tax structures based on IRS elections.

  3. FICA Taxes: Avoid conducting business through a single-member LLC. Opt instead for a partnership LLC to alter the taxation of investors. Seek guidance from your accountant to navigate these nuances.

  4. 1031 Exchanges: Defer capital gains tax by reinvesting profits from the sale of one property into another "like-kind" asset. Consult a Qualified Intermediary (Real Estate attorney, CPA, or title company) to navigate this process. Beware of the strict timelines and DO NOT touch the exchange funds during this process or it will trigger a tax event!

  5. DSTs: Similar to a 1031 Exchange, DSTs offer a way to defer capital gains tax. This passive investment strategy allows you to invest the proceeds from a property sale into a DST without tight deadlines for acquiring replacement properties.


Remember, while real estate investments offer significant tax benefits, they aren't completely tax-free. Capital gains and depreciation recapture are still factors to consider. The specific impact depends on the hold time and your individual tax bracket. Consult with your CPA to understand your unique situation and ask about the strategies listed here. Only they can help you effectively tax plan for your unique scenarios.


Final Thought


Passive real estate investing in a syndication can help leverage deductions, leading to greater income retention and reduced tax liabilities. Our objective is to assist Limited Partners in generating passive income, providing them with both time freedom and financial freedom. You don't need to be a real estate expert, manage properties, or spend months searching for the right investment. With passive investments in real estate syndications, you can still reap these benefits. If you are interested in finding out more about Passive Investments in real estate syndication, join our mailing list or schedule some time to speak with us!



We look forward to partnering with you and helping you enjoy these advantages!


Here's to your Success,


Your Skyscape Equity Partners

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