Passive Real Estate Investing

Passive real estate investments, particularly through real estate syndications, are gaining popularity among investors seeking to build wealth and leverage the tax benefits embedded in the U.S. tax code. If you’re making around $100,000 a year, real estate syndications can help you reduce your tax liability, while still providing income and long-term appreciation potential.

Syndications allow you to pool your capital with other investors to acquire larger properties, such as apartment buildings or commercial properties, without the need to manage day-to-day operations. By investing passively, you can tap into significant tax advantages that are tailored to real estate, helping you keep more of your hard-earned money.

Let’s dive deeper into the tax advantages of real estate syndications, explaining how each one can work to reduce your tax burden with detailed examples.

Depreciation Deductions: The Key to Reducing Taxable Income

Depreciation is one of the most powerful tax tools available to real estate investors, especially those involved in syndications. In simple terms, depreciation allows you to deduct the wear and tear on the property over time, reducing your taxable income—even if the property is appreciating in market value.

Example: Depreciation in Action

Imagine you invest $50,000 into a syndication that acquires a $5 million apartment building. The building itself (excluding land) is valued at $4 million. Under the IRS depreciation schedule for residential properties, the building can be depreciated over 27.5 years. This means the syndicate can claim a depreciation expense of roughly:

4,000,00027.5=145,454.54 per year\frac{4,000,000}{27.5} = 145,454.54 \text{ per year}27.54,000,000​=145,454.54 per year

Now, let’s say you hold a 1% share in the syndication, based on your $50,000 investment. Your share of the depreciation would be:

$$1\%\times 145,454.54=1,454.55\text{ per year}$$

If the syndication generates $5,000 in annual rental income for you, that $1,454.55 depreciation deduction will reduce your taxable rental income to $3,545.45. This results in significantly less tax liability compared to having to pay tax on the full $5,000.

For someone making $100,000 a year, this reduction in income can make a meaningful difference, as it could help keep you in a lower tax bracket or reduce the overall amount of income subject to higher tax rates.

Passive Loss Deductions: Offsetting Income and Carrying Forward Losses

The IRS considers income from real estate syndications as passive income, and any losses generated by these investments are classified as passive losses. One major tax advantage for passive investors is the ability to use passive losses to offset passive income. If you’re earning $100,000 from your primary job, this passive classification can be a boon because passive losses can offset income from other passive investments.

Example: Passive Losses

Continuing with the previous example, if your share of the syndication’s depreciation and other deductible expenses exceeds the rental income you receive, you might end up with a passive loss. Let’s say your share of total deductible expenses (including depreciation) is $6,000, but the rental income you receive is $5,000. This would create a passive loss of $1,000.

$$6,000\text{ (deductions)}-5,000\text{ (rental income)}=1,000\text{ passive loss}$$

While you can’t use this passive loss to reduce your salary or wage income, you can carry it forward and use it to offset future passive income. This means that if the syndication produces a higher rental income next year, or you invest in another syndication, you can apply these losses to reduce future taxable passive income.

Capital Gains Tax Benefits: Long-Term Holding Pays Off

When you eventually sell your interest in the syndication (or the syndication sells the property), any profits made will typically be treated as capital gains, rather than ordinary income. For assets held for more than a year, the IRS taxes these gains at long-term capital gains rates, which are lower than ordinary income tax rates.

Example: Lower Tax Rate on Capital Gains

Assume that after five years, the syndication sells the property and your $50,000 investment has appreciated to $75,000, resulting in a $25,000 gain. For someone earning $100,000 annually, the long-term capital gains tax rate would likely be 15% (based on current tax brackets). The tax owed on this gain would be:

$$15\%\times 25,000=3,750$$

If this $25,000 were taxed as ordinary income, you could be subject to a 24% tax rate, resulting in a tax bill of $6,000. The capital gains treatment therefore saves you $2,250 in taxes in this scenario.

1031 Exchange: Deferring Taxes Indefinitely

A 1031 exchange is another powerful tax-saving strategy for real estate syndication investors. It allows you to defer capital gains taxes by reinvesting the proceeds from the sale of a property into another “like-kind” property. For syndication investors, this means that when a property is sold, the syndicator can reinvest the gains into another property, and you, as an investor, won’t pay taxes on your share of the gains until you ultimately cash out.

Example: Using a 1031 Exchange

Imagine the same scenario where your $50,000 investment grows to $75,000. Rather than paying capital gains taxes on the $25,000 profit, the syndicator reinvests the proceeds into a new property using a 1031 exchange. You can continue deferring the taxes indefinitely, building wealth without an immediate tax hit.

Mortgage Interest Deduction: Maximizing Leverage

Syndications often use debt (mortgages) to acquire properties. The interest paid on the mortgage is deductible, and this deduction is shared among all the investors in proportion to their ownership stake. The benefit to you as a passive investor is that you receive a portion of the interest deduction, which can further reduce your taxable income.

Example: Mortgage Interest Deduction

Let’s say the syndication has a mortgage with $200,000 in annual interest payments. If you own 1% of the syndication, you can deduct $2,000 of those interest payments on your taxes. This deduction is on top of the depreciation and other expenses that you’re already deducting, further lowering your taxable rental income.

Qualified Business Income (QBI) Deduction: A 20% Bonus

The Qualified Business Income (QBI) deduction, introduced by the 2017 Tax Cuts and Jobs Act, provides up to a 20% deduction on qualified rental income for real estate businesses. Syndications can often qualify as a “trade or business” under the IRS rules, allowing passive investors to take advantage of this additional deduction.

Example: QBI Deduction

If your share of the syndication’s rental income is $5,000 and the syndication qualifies for the QBI deduction, you can deduct up to 20% of that income, or $1,000, from your taxable income. This further reduces the amount of rental income subject to tax, effectively lowering your overall tax bill.

Conclusion

For individuals earning around $100,000 a year, investing in real estate syndications offers a range of tax advantages that can significantly reduce your taxable income. From depreciation deductions and passive loss offsets to capital gains treatment and the 1031 exchange, real estate syndications provide multiple layers of tax savings that other investment vehicles often lack.

By understanding and utilizing these tax benefits, passive investors can increase their after-tax returns, build long-term wealth, and keep more money in their pockets. Whether you’re looking to diversify your portfolio or take advantage of real estate’s unique tax structure, syndications are a smart and tax-efficient way to invest.