As Seen on Before You Invest in ‘Crowdfunded’ Real Estate, Consider the Tax Implications

Many syndicated real estate investments miss out on a major tax benefit, but there are some ways to do your deal that avoid that issue.

By Dwight Kay, CEO & Founder, Kay Properties & Investments, LLC 

The rise in online real estate investing in recent years has been remarkable. As the global consulting firm EY estimates, the online real estate investing market worldwide is expected to be $8.3 billion in 2020, with no sign of slowing.

For all the benefits of joining the crowd, there is one downside to many syndicated investments that every real estate investor should know. Most co-investment opportunities are in the form of limited partnerships (LPs) or limited liability companies (LLCs). That’s not necessarily bad, except that those forms of syndicated ownership do not qualify for one of the most advantageous real estate tax benefits available in the U.S.: 1031 exchanges.

Also known as like-kind exchanges, 1031 exchanges allow investors to defer taxes on capital gains at the time real property investments are sold if the net equity is reinvested into a similar investment property of the same or greater value. With a 1031 exchange, an apartment building can be exchanged for a warehouse, a warehouse for a piece of raw land, a piece of raw land for a single-family rental property, etc.

The net effect of 1031 exchange investing: The initial invested capital and the gain can continue to grow, potentially, without immediate tax consequences. Then, if and when the new investment is sold without the equity reinvested in another exchange property, the prior gain would be recognized. There are some finer points, and investors should consult their tax or legal advisers prior to selling or exchanging a property, as everyone’s tax situation is different.

A Hypothetical Example

If an investor places $100,000 of capital into a crowdfunded LLC offering that is purchasing an apartment building, and the property sells after a few years and has a gain, the investor will be subject to depreciation recapture tax of 25%, federal capital gains tax of 15%-20% (depending on their income tax bracket), state capital gains tax of 0%-13.3% (depending on the investor’s home state) and an additional 3.8% Medicare surtax.  All told, the gain from the crowdfunded investment may be subject to taxation of 20%-45%+, leaving the investor with far fewer investment dollars to reinvest.

However, if that investor had participated in a 1031 exchange program with the $100,000 investment, he or she would be able to defer 100% of the potential gain and depreciation recapture coming out of the sale, thus keeping more of their capital invested in real estate to generate potential cash flow and appreciation versus paying a large tax bill.

To be clear: A 1031 exchange allows the participating investor to defer federal and state capital gains taxes, as well as other taxes. It’s a potentially big tax benefit, depending on your individual situation, which is why approximately one-third of all income property sales in the U.S. involve a 1031 exchange.

2 Ways to Pool Your Money and Still Qualify for a 1031 Exchange

But if most crowdfunded investments don’t qualify for 1031-exchange treatment, which assets do? The IRS identifies two types of co-ownership structures that are allowable for 1031 exchanges: Delaware Statutory Trusts (DSTs) and Tenants-in-Common (TIC) investments.

DSTs and TICs have been around since the early 2000s and have demonstrated their efficacy as direct real estate ownership vehicles. Most types of real estate can be owned in a DST, including retail, office and multifamily properties, and, notably, a single DST can own multiple properties, serving as a diversification* vehicle. Mountain Dell Consulting reports that investment in DSTs and TICs reached a post-recession high in 2019, and the trend continues.

As you consider the wide range of online real estate investment opportunities, keep in mind that not all investments are created equal, since with a typical LLC or LP offering when the property is sold investors will not be able to participate in a 1031 exchange and thus will be hit with a tax bill.

*Diversification does not guarantee profits or protect against losses.

About Kay Properties and

Kay Properties is a national Delaware Statutory Trust (DST) investment firm. The platform provides access to the marketplace of DSTs from over 25 different sponsor companies, custom DSTs only available to Kay clients, independent advice on DST sponsor companies, full due diligence and vetting on each DST (typically 20-40 DSTs) and a DST secondary market.  Kay Properties team members collectively have over 150 years of real estate experience, are licensed in all 50 states, and have participated in over $30 Billion of DST 1031 investments.

This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing.  IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation.  There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed.

Nothing contained on this website constitutes tax, legal, insurance or investment advice, nor does it constitute a solicitation or an offer to buy or sell any security or other financial instrument. Securities offered through FNEX Capital, member FINRASIPC.