Possible tax advantages of private real estate investments
The following is a guest post by Nathan Clayberg, vice president of MLG Capital, a private commercial real estate company.
As anyone reading this blog knows, my two favorite aspects of real estate investing are cash flow and tax savings.
I asked Nathan to write a blog post explaining how a private real estate company views these two aspects for its investors.
MLG Capital has been a partner of Passive Income MD for many years. This is not a sponsored post.
Many of us have probably heard of the old adage, “Don’t count your chickens before they hatch.” Or: “You cannot put the cart in front of the horse.” With no real experience raising chickens or carting carts, the general message is clear: often it is important to take things one step at a time, and the mess of the order of priority can negatively affect the desired outcome.
To maximize wealth from real estate, it is important for investors to carefully consider a two-step process: first, making smart real estate deals, and second, doing excellent tax planning.
The chronology of this process is important because failure to carefully examine step one can make step two completely irrelevant – you need to make money in the business before you can figure out how to manage taxes!
At MLG Capital, we have a long track record of the type of smart deals that ultimately make our investors’ money. How we do this, however, is a topic for another day. This article is about step two of the process – how real estate can be used to maximize the after-tax returns earned by investors.
Ultimately, the most important thing is how much return you put in your pocket as an investor. This article summarizes some of the tax benefits we have been able to obtain for our investors.
Deferred tax income
When buying an apartment building, we usually use a Cost separation study to split the purchase into different assets. Each asset can then be treated separately for depreciation purposes. Additionally, assignments to assets with shorter class lifetimes and assets eligible for bonus depreciation can greatly speed up the deduction for favorable depreciation.
This depreciation can then be used to reduce rental income and even create beneficial taxable losses for investors.
We often find that a loss allocation in the first year can be around 50-60% of the invested capital and these beneficial losses are all returned to investors! Of course, these are just paper losses as the assets are still generating positive cash flow. However, these losses can be very substantial as they can typically be used to offset and defer other passive income that investors may have in their portfolio.
If these losses cannot be used each year, they can often be carried forward to offset future passive income.
This benefit typically leads to a significant one deferred tax income for investors. This can be a very powerful tool. Especially for people who are highly compensated and highly taxed. This deferred income is usually classified as ordinary income and can often be subject to a tax rate of 40% or more (plus state taxes)!
The ability to defer these returns makes sense as investors get the benefit from it the time value of money – A dollar in your pocket today is worth more than a dollar in your pocket five years from now.
Fact: As of December 31, 2020, our private funds have each produced a series cumulative beneficial ordinary loss throughout the life cycle of the fund while delivering desirable returns for investors.
Permanent tax savings
While the deferred income benefit is good, the ultimate goal is to generate sustainable tax-efficient income for investors. Our tax strategy focuses on capturing the delta between normal income tax rates and capital gains rates, often with an overall tax rate in the mid-range of 20%.
This difference in tax rates can be dramatic for highly compensated individuals who are taxed at the highest normal federal tax rates. If the ordinary passive losses (resulting from previous accelerated depreciation) due to the triggering of passive capital gains (sale of the asset) can be used, a highly compensated person may very well benefit from tax savings (20-25%) and ordinary due to the difference in capital gains rates Rates (37% +).
If you’d like to learn more about these and other tax strategies, our CEO, Tim Wallen, wrote an article that you might find interesting.
Don’t forget the main principles
So if you want to create wealth through real estate investments, think again about the two core principles: 1) find smart real estate deals and 2) make sure you do good tax planning.
Our range of funds aims to deliver tax-efficient cash-on-cash returns, quarterly distributions and an investor appreciation over time. You can learn more here. Take the first or next step with us on your way to real estate investments.
This press release is for informational purposes only and is published in its entirety with reference to the confidential private placement memorandum (as amended or supplemented by the “Memorandum”) of MLG Private Fund V LLC (the “Main Fund”) and MLG Dividend Fund V LLC (the “Co-investment funds” and together with the main fund the “Fund”), the articles of association with limited liability (the “LLCAs”) of the main fund and the co-investment fund, each as amended and / or form amended from time to time and an associated subscription agreement , copies of which are available on request and should be checked prior to purchasing units in the Fund. This press release is not intended to be used as a basis for any investment decision and is neither complete nor should it be accepted as complete. The contents of this press release are not to be regarded as legal, business or tax advice and each prospective investor should consult their own lawyer, business advisor and tax advisor for legal, business or tax advice. This press release does not constitute an offer or a solicitation in any state or other jurisdiction to subscribe for or acquire limited partner interests in any offer. The recipients of this press release agree that the Manager and the Offers, its affiliates and their respective partners, members, employees, officers, directors, agents and agents shall not be liable for any misstatement or omission of facts or for any opinion expressed herein take. Investing in a private offering is subject to various risks, none of which are described here