Crowdfunding real estate has gained wide appeal in the past couple of years. The experience and unexperienced alike are all diving into this unique opportunity to invest in real estate.
What are the tax implications of investing in crowdfunding real estate? Is it taxed like a stock? A CD? A business?
Unwinding how crowdfunding real estate is taxed can get complex depending on the type of investment.
In this article, we look at a few different scenarios to help you get a handle on how crowdfunding real estate investments are taxed.
Let’s first look at a few of the different structures and investor types that are commonly found in crowdfunding real estate investments.
There are two types of investors in a crowdfunded real estate investment: Accredited and non accredited.
An accredited investor has more opportunities to invest than a non accredited investor but they also bear more risks. SEC Rule 501 of Regulation D defines accredited investor.
These investors have an annual income of least $200,000 for the previous two years and a net worth of more than $1 million.
Some real estate crowdfunded sites allow only accredited investors to invest in their projects.
Projects that an accredited investor will often invest in are called equity projects. This means the investor is actually becoming a partner in a company, which is often an LLC (Limited Liability Company) or LP (Limited Partner).
The LLC will then invest in specific real estate projects.
Profits and losses from an LLC flow through to investors. Because of this flow through, the LLC doesn’t pay any taxes. Investors instead pay the taxes.
The other common form of real estate crowdfunding is through debt. For this type of investment, investors do not need to be accredited and do not own equity in a company. With a debt investment, investors earn interest.
Most debt structures allow investor to buy shares in a fund, sometimes called eREITs. In this scenario, it is similar to investing in a stock or CD.
Tax Implication Of The Business/Deal Structure
Non accredited investors buying shares of a fund have the simplest tax impacts.
They receive a 1099-INT from the crowdfunding real estate company they are investing with and are taxed at their ordinary income tax rate.
If the investor is invested in multiple funds, their investments can be aggregated into one 1099-INT rather than receiving an individual 1099-INT for each fund.
For investors who are investing in equity investments, things get more complicated. These investors will receive a K1 tax form. A K1 is for income through business partnerships.
Paul Sundin, a CPA and tax strategist, elaborated in an interview with RealtyShares.com on the relation between the LLC and K1, “…in a structure where LLC, excuse me, RealtyShares investors are investing into a RealtyShares LLC, which is in turn investing into a sponsorship or a sponsor deal, that will be a partnership return on the RealtyShares [group], and that’s where the K-1 will come out of that specific transaction, and it will flow through the tax attributes to the individual investors.”
Equity investors might also receive interest income and or capital gains. Interest income can be ordinary income as previously mentioned.
Capital gains, from investments held for more than one year, are considered long-term and taxed at a more favorable rate of 15% or 20%.
Some people believe they can’t claim a loss from their K1. That isn’t entirely true. Passive losses on a K1 can only offset other passive income. Not investment income. Passive losses can be carried forward to the next year.
Equity deals that have quarterly distributions (cash flow) can be taxed as income. On buy and hold investments (long-term), cash flow can be offset by depreciation and other deductions, which can lead to a loss.
At the end of the long-term investment, usually when the property is sold, gains or losses from the property flow through to investors on the K1.
Federal vs. State Taxes
For equity investors, they might fall under state nexus, which may not be their state of residence. This can vary by state. If a state is enforcing the issue, investors will need to file a return with that state.
The investor’s state of resident will often provide a credit or allocation in this case.
For states that do not have income taxes, there may be a notice filing that is required.
As you can see, there can be a lot of that goes into tax consequences of crowdfunding real estate investments, especially for equity investments where investors receive K1s.
Non accredited investors who invest in funds have the simplest tax scenario.
They receive a 1099-INT and pay ordinary income taxes. It’s not much different from receiving a 1099-INT for interest income on a CD.
Of course, everyone’s tax situation is different. It’s best to work with a CPA to better understand your unique tax scenario and the impact crowdfunding real estate will have on it.
Do you invest in crowdfunded real estate or would you ever consider it?