Tax Considerations in Real Estate Investing

Tax Considerations in Real Estate Investing_960x725_Website

Brian D. Milovich

Managing Principal, Calvera Partners

Taxation is one of the hottest topics for our investors. Not only are they concerned about how much they might have to pay, but they’re also concerned with the potential hassle that tax reporting can create. When making an investment in real estate, it’s important to have a tax plan in mind and a full understanding of your filing requirements and the potential cost.

A traditional one-off property investment, whether owned by yourself or through a syndicator/sponsor, can have a number of tax-related items to keep track of, though should be relatively straight forward. You will likely receive a federal K1 and the state equivalent for wherever the property is located. If the property happens to be in a state that doesn’t have personal income tax, then you may not even receive a state K1. However, just because some states don’t have personal income taxes doesn’t mean they don’t collect taxes. For example, gross receipts taxes not only collect a percentage of annual revenue or income, but they can also tax your sale proceeds. If you’ve invested in a deal through a sponsor, they’ve likely handled this at the entity level. There’s also the issue of taxable losses. Most investors we know cannot fully use these. Yes, they can be great if you have a sizable portfolio or sold an asset, and the losses can offset some or all of the gains. But, the losses keep piling up until a time when they’re eligible to be used.

Investing in a private real estate fund can reduce the number of federal K1s (you should receive just one for the portfolio), but it can exacerbate the number of state filings for the investor. Wherever that fund owns property, you’re probably going to receive a state K1 for that investment. That also means having to file personal tax returns in all of those states. When this happens, it’s best to hire a tax professional to navigate this for you and to keep track of your gains or losses. Nobody enjoys the cost of paying an accountant for each additional state filing, but it can be looked at as a cost of doing business and having access to the fund. A fund structure should actually be cheaper for the filer than being in multiple separate transactions. The same consideration regarding taxable losses applies here. The one caveat is that in a fund, it is more likely that taxable losses can be used given multiple properties and the potential to offset gains.

Our new Calvera Income and Growth Fund is structured to own property through a REIT subsidiary. One big benefit of this structure is it eliminates the state tax return for limited partners. This brings the hassle factor down considerably and is one of the key reasons we chose this structure. Investors will still receive a federal K1, and the REIT dividends received may even qualify for a 20% tax discount through 12/31/2025 for non-corporate limited partners. The REIT can generate taxable losses just like in other ownership forms, but those net operating losses are tracked at the REIT level, moving the tracking burden away from the individual investor. Lastly, if you’re worried about unrelated business taxable income (UBTI) because you want to invest through a retirement account, the REIT ownership structure minimizes this risk. All types of investing have different levels of hassle in regard to filing requirements and complexity of K1s. We believe the REIT structure is the best to minimize the hassle for investors.

The other big tax consideration involves how capital gains are treated. A 1031 like-kind exchange is available in many structures, provided investors consent to it. A 1031 exchange allows you to purchase a new property (with specific timing and other guidelines) and defer the tax until a later date. For example, let’s say an initial $200k investment generated $400k at sale, producing a $200k gain. If a 1031 exchange is elected, taxes are deferred and the total $400k of net sale proceeds (the $200k original investment plus $200k gain) can be reinvested in a new property. If the taxes were paid on the gain, perhaps only $300k ($200k original + $100k after tax) could be reinvested elsewhere. That loss of $100k has a big impact over time. The Calvera Income and Growth Fund is set up to do 1031 exchanges for all REIT-owned properties. This keeps your money working for you.

Lastly, an alternative to 1031 exchanges uses cost segregation studies to find assets subject to bonus depreciation. If enough bonus depreciation is found in a new property, it might generate enough taxable losses to offset the gain from the sale on another property. However, just like with a 1031 exchange, you must do this every time you sell or there will be a large tax bill due. Bonus depreciation was part of a tax law that is phasing out over time and is not as lucrative as it once was. The focus will return once again to 1031 exchanges.

Taxes are unavoidable, and if you have to pay taxes, chances are the investment made money. That’s a good thing. One of our objectives when formulating our new investment fund was to minimize and streamline the tax burden for our investors. We wanted to address some of the common themes in feedback we have received over the years from our investors who 1) do not like filing tax returns in multiple states, 2) do not like to pay capital gains tax and then turnaround and reinvest with Calvera (i.e., they lost investable capital), and 3) already know about 1031 exchanges and want to be able to use them in our investments. Over time we’ve found that everyone is unique and has different goals for their money. It’s never a bad idea to discuss this out in the open with your real estate and tax professional before deciding on a new investment.

Mr. Milovich is not a tax professional. He advises you to seek the opinion of a competent tax professional. Please see the FAQ section for additional information on taxes and the structure of the Calvera Income and Growth Fund.

Author

For more details about Calvera’s investment offerings, click here.

CONTACT
SAN FRANCISCO OFFICE:
2 Embarcadero Center, 8th Floor
San Francisco, CA 94111

MINNEAPOLIS OFFICE:
729 Washington Ave N, Suite 600
Minneapolis, MN 55401

GET INSIDER UPDATES

GET INSIDER UPDATES

© 2024 CALVERA PARTNERS

Performance data listed in this website or is otherwise provided by Calvera Partners, LLC, or its affiliates (“Calvera”) with respect to a particular property or project represents past performance calculated for the relevant project and does not purport to reflect the overall performance of any private funds managed by Calvera, which may include other projects, as well as charge additional fees or carried interest, or have additional expenses, which would reduce the overall performance of the project from the perspective of a fund investor. Past performance does not guarantee future results; Current performance may be lower or higher than performance data presented. Calvera is not required by law to follow any standard methodology when calculating and representing performance data; the performance of any of Calvera’s projects may not be directly comparable to the performance of other investment vehicles or funds; and qualified potential investors can contact Calvera Partners for more current performance data of any private funds managed by Calvera. 

This website is provided for informational purposes only. Nothing contained in this material is an offer or solicitation to buy or sell any security. In addition, (i) any securities offered to investors that respond to any general solicitation or general advertisement made by Calvera, may be sold only to accredited investors; (ii) such securities will be offered in reliance on an exemption from the registration requirements of the Securities Act and such securities offered are not subject to the protections of the Investment Company Act or required to comply with specific disclosure requirements that apply to registration under the Securities Act; (iii) Neither the SEC, nor any state securities regulator, has passed upon the merits of or given its approval to any securities offered by Calvera, the terms of the offering, or the accuracy or completeness of any offering materials or the accuracy or completeness of any of the information or material provided by or through this website; (iv) the securities will be subject to legal restrictions on transfer and resale and investors should not assume they will be able to resell their securities; and (v) investing in securities involves significant risks, and investors should be able to bear the loss of their investment. Please click here for additional important disclosures.