Apartment syndications appeal to a lot of passive investors, because they have a number of tax benefits (the most important of which is depreciation). Fixed asset items are long-term, tangible pieces of property or equipment that are used in specific operations to generate income and are not expected to be consumed or converted into cash within a year. At apartment complexes, these assets can depreciate in value over time because of normal “wear and tear.” This amount can be deducted from your taxable income every year to reflect this reduction in value. The IRS classifies every depreciable item according to the length of their useful life, and it’s during this period that the fixed asset can be fully depreciated.
Every year, the partner’s accountant will create a Schedule K-1 for the limited partners for each apartment syndication investment. The passive investors will then file the K-1 with their tax returns so they can report their share of the profits, losses, deductions, and credits to the IRS (including any depreciation expenses that was passed on to them).
A Schedule K-1 is a federal tax document that’s used to report any income, losses, and dividends of any partners of a business or financial entity (including the shareholders of an S Corporation). A Schedule K-1 is prepared for each partner and needs to be included with his or her personal tax return. An S Corporation reports any activity on Form 1120S, while a partnership will report it on Form 1065.
The Federal Tax Code allows entities (such as partnerships, S corporations, trusts and estates) to issue a Schedule K-1 to any owners or partners in an investment. The direct ownership that passive investors get from investing into a syndication can come with certain “pass-through tax advantages.” All the investment income and expenses flow down from that partnership to every single owner in the deal. The partnership itself doesn’t pay the taxes. Each individual person is responsible for his or her own share.
The General Partner (GP) refers to the syndicator or sponsor of a specific deal. This person would prepare and file Form 1065 and would then calculate a Schedule K-1 tax form that details the share of each limited partner (LP) or passive investor. This will include any income, losses, deductions, credits, and distributions that were given to them in that specific year. The passive investors or LP’s would then file this form with their personal tax return.
There are four main boxes that every passive investor must be able to understand as they read their Schedule K-1:
Be sure to speak to a tax professional for more information.
Filing a tax return for a partnership is a complicated task that requires help from many experts. It makes sure that the information is accurate and that the partnership can take advantage of all the available deductions. This part is critical because every investor will get their Schedule K-1 based on the partnership’s filings. It will also take some time to put everything together and to properly file the partnership’s return.
Individual investors or LP’s should expect to get their Schedule K-1 sometime between mid-March and early April. But in some cases, the filing is so complicated that it may require the partnership to file an extension (which would delay the process). Stay in touch with whoever the GP or sponsor is for the deal in which you have invested, so you can get a good idea of when you should expect to receive your Schedule K-1.
According to the IRS, all rental real estate income is passive. So, passive losses from rentals can only be offset by other passive income or gain. The tax benefits of passively investing into multifamily syndications are one of its main advantages, especially when you compare it to investing in a Real Estate Investment Trust (REIT). These benefits allow investors to create paper losses through what the IRS calls “depreciation.” It will allow you to write off the normal wear and tear that comes from using the building (but not the land itself) over a period of 27 ½ years.
Another way to accelerate that depreciation and to claim more paper losses is through something called a “cost segregation” study. This would require the hiring of a private engineer, who would come out to establish the property’s value. Certain items (such as plumbing fixtures, windows, and equipment) are considered “personal property,” and the goal is to find the total value of each of these items so you can depreciate them over the same period.
If you have a building that produced $100,000 in cash flow but you claim -$150,000 of depreciation, you would have a -$50,000 loss for that particular partnership. If there are two partners, each one would get a Schedule K-1 that reflects a -$25,000 net rental loss (even though each person made $50,000 in cash flow).
Unlike your earned income, the Schedule K-1 you receive each year will reflect your net rental real estate revenue (which is taxed at a lower rate after depreciation is subtracted). The money you make from working a W-2 job or from your business is referred to as “earned income” and will be taxed at the highest effective rate.
Depending on where you live in the United States, you will have to pay both federal and state income taxes. And you’ll have to submit your Schedule K-1 with your personal income tax return once you get it. If it shows a positive cash flow, you’ll have to pay the marginal tax rate on that revenue. But if it shows a loss, you won’t have to pay anything.
If you have earnings reported on a Schedule K-1 in addition to ordinary or business income, it’s a good idea to hire a professional accountant. You may still have to pay tax on any money you have earned from retirement accounts or from shares that are held inside a retirement plan (what is referred to as “unrelated business taxable income,” or UBTI).
Other examples of UBTI would include but may not be limited to:
In short, UBTI would be any income that’s considered “ordinary.” For many years, certain types of retirement accounts would not be taxed in this way. But any earnings that aren’t put into retirement plans aren’t considered UBTI, which would be listed on your Schedule K-1. You’re required to report this taxable amount on Line 43 of your 1040 tax return and will need to fill out Form 990-T. If you don’t pay both income and distribution taxes on this amount, you’ll receive a deficiency notice.
Because rental real estate activity is considered passive, you can only offset it with passive losses. You won’t be able to apply any passive losses toward your active or earned income to reduce your tax liability, but it can be done if you qualify for real estate professional status (which would allow you to carry over your losses). It’s usually harder to qualify for this status if you’re not a full-time real estate investor and if you have a full-time job outside of real estate, but there are cases where couples can qualify for real estate professional status if they file jointly.
Investing in Opportunity Zones has many advantages from tax perspective. I’ve listed three of the most common below: When you roll over capital gains into a Qualified Opportunity Fund within 180 days, you can defer their recognition until December 31, 2026. For most taxpayers, the tax on the gains would be due in April 2027. […]
With the 2017 Tax Cuts and Jobs Act, the federal government was able to create a wealth-building vehicle for investors by giving them access to opportunity zone funds. Trevor explains the pros and cons.