As a passive investor, you receive all the tax benefits an active investor receives. An LLC which owns the property is classified as a ‘pass-through entity’, which means that any income the LLC generates is passed through directly to the owners of the entity (investors). This means the income is exempt from corporate income tax and is instead taxed as part of the personal income tax an investor is subject to.

This is separate from REITs, in which investors are investing with a company, which is subject to corporate tax. As such, the tax treatment of REITs differ from syndications. One of the most common words you will hear frequently is depreciation.

Depreciation

Depreciation allows investors to write off the value of an asset over time based on wear and tear and the useful life of an asset. Wear and tear is the normal degradation of certain aspects of the property resulting from normal use, even when properly maintained (such as replacing carpet or windows). Useful life of an asset refers to an estimate of the average number of years an asset (such as the property) is considered usable before its value is fully depreciated. The IRS allows you to write off the value of the property for 27.5 years which is applicable only to the property and not the land.

Bonus depreciation

The IRS allows for bonus depreciation for properties acquired after September 27, 2017 which accelerates tax benefits. This is done through a cost segregation study where an engineer itemizes individual components to their respective, estimated serviceable life.

The study can reclassify items such as appliances, carpets, window treatments into 5 year items. By segregating items into different lifespan buckets (i.e. 5 years, 15 years, etc), this allows for greater depreciation instead of using a straight line depreciation. This depreciation write off expense will pass through to investors to offset their passive income.

IRS passivity rule

The passive activity loss rules are a set of IRS rules which states that passive losses can be used to only offset passive income. Passive income or loss comes from businesses in which you don’t materially participate in and all rental properties you own.

This is great news for real estate investors if they have a rental income or invest in businesses where they have an inactive role. Paper loss from investing in syndications can offset passive income from other investments which allows investors to pay less taxes.