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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. In the episode below, we discuss two major tax benefits of adopting energy-efficient practices. Click below to watch.

As a real estate investor, you can take advantage of government rewards by adopting energy-efficient technologies and practices. Two incentives investors should know about are the Section 179D deduction and the 45L Tax Credit. Here’s what you need to know:

Section 179D: The Energy-Efficient Building Deduction

This deduction is for building owners who install energy-efficient systems in their commercial properties. This includes interior lighting, mechanical systems and the building envelope. For government and nonprofit buildings, this deduction extends to designers, architects, and contractors.

For properties placed in service before January 2023: The deduction is up to $1.80 per square foot, indexed for inflation.
For Properties Placed in Service Between January 2023 and December 2032: The deduction is up to $5.00 per square foot -indexed for inflation.

However, projects initiated after January 2023 may require adherence to prevailing wage standards to qualify for the higher deduction amount.

45L Tax Credit

This credit is designed for multifamily developers and homebuilders who construct or reconstruct qualified energy-efficient homes, and then sell or lease them.

To qualify, developers must undergo a pre-certification process and regular building inspections, as well as pay prevailing wages.

This credit can be worth up to $5,000 per dwelling unit, depending on the type of home and energy-efficient measures implemented. For example, a developer with a one-hundred-unit development could receive a credit of 500,000!

If you believe your projects might qualify for these credits and deductions, consult with your financial advisor or tax professional to explore your eligibility and maximize your tax benefits.

This material has been prepared for informational purposes only and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities, and how you can make the most of them. Below, we talk about the benefits of investing in a Self-Directed IRA (SDIRA).

If you’re an independent-minded investor looking to diversify, an SDIRA, or Self-Directed IRA, might be the way to go.

An SDIRA is an individual retirement account that can hold alternative investments. Besides for standard investments – like stocks, bonds, cash, money market funds and mutual funds, an investor can hold assets that aren’t typically part of a retirement portfolio, like investment real estate. A custodian or trustee must administer the account, but SDIRAs are directly managed by the account holder, which is why they’re called self-directed.

SDIRAs come with complex rules and carry some risk, but they offer the opportunity for higher returns and greater diversification.

Self-directed IRAs are generally only available through specialized firms, like trust companies and certain banks. As custodians, these entities are not allowed to give financial or investment advice about your SDIRA. The account holder is responsible for all research, due diligence, and asset management within the account. Some downsides of maintaining an SDIRA include custodial fees and – if you’re not a savvy investor – exposure to fraud.

When investing in real estate through an SDIRA, the IRA’s funds are used to purchase the property. That means that the IRA will own the property, and it can only be used for investment purposes. Know that there are potential tax consequences when an SDIRA carries debt – like a mortgage – and the SDIRA will probably get taxed at a higher rate.

The upsides of investing in an SDIRA are its flexibility, diversification and the control it gives to the investor. SDIRAs offer a wide range of investment options, so the investor is not limited to stocks, bonds and mutual funds. SDIRA holders may also invest in real estate, private debt, privately held companies or funds, or even cryptocurrency. SDIRAs give the investor control to choose which specific assets he believes will perform the most advantageously based on his own research, due diligence and risk tolerance. And similarly to any IRA, investors benefit from tax-deferred or tax-free growth on their investments.

There are a number of rules an investor must be aware of when considering investing in real estate through an SDIRA, like steering clear of “prohibited transactions” and not engaging in transactions with “disqualified persons.”

Disqualified persons are people or entities that cannot be involved in any direct or indirect deals, investments, or transactions with the SDIRA. These persons include the investor, any beneficiaries of the IRA, all family members, any of the IRA’s service providers, any entities (corporations, partnerships etc.) that are owned by a disqualified person, or officer, shareholder or employee of those entities. The investor cannot transfer SDIRA income, property, or investments to a disqualified person, or lend IRA money or to a disqualified person.

Prohibited transactions are those that earn the investor personal financial gain on the investment. The investor may not sell, exchange or lease their personal property to the SDIRA as an investment (a.k.a “double dealing”). Moreover, the investor cannot supply goods, services or facilities to disqualified persons or allow fiduciaries to use the SDIRA’s income or investment(s) for their own interest. In practicality, this means that if you own a construction company or are another type of service provider, the SDIRA cannot contract with your company to do work on the property or provide it with any service. All income from SDIRA assets must be put back in the IRA and the investor must make sure that all rental income from an investment property owned by the SDIRA is deposited in the SDIRA account, and not in his personal account. The investor is not even allowed to spend the night in their SDIRA-owned rental property.

The consequences of breaking these rules are immediate. If an IRA owner or their beneficiaries engage in a prohibited transaction, the account stops acting as an IRA as of the first day of that year. The law will look at it as if the IRA had distributed all its assets to the IRA holder at fair market value as of the first day of the year. When the total value of the former-SDIRA is more than the basis in the IRA – which was the investor’s goal – the owner will show a taxable gain that will be included in their income. Depending on the infringement, they may even be subject to penalties and interest.

Reach out to your financial advisor to learn if an SDIRA is the right tool for you.

This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. In the episode below, we cover the main advantages of investing in student rental properties.

Student housing properties have earned a significant niche in the commercial real estate market, and while they may evoke a natural reluctance on the part of the investor, they actually offer several unique investment advantages.

Investing in student housing properties often carries less risk than investing in traditional multi-family properties. The need for student housing is on the rise, with a projected 46 million people falling into the college age-range by 2031. In response, off-campus rentals have been attracting capital from savvy investors.

Universities and colleges are historically unaffected by recession or economic flux. Education is always a commodity in demand. By association, student housing properties are also less susceptible to economic downswings. College enrollment runs in continuous cycles, so new housing is needed every semester. This means that demand for this type of property remains stable and cash flows are predictable, albeit the downside of constant turnover.

Because student spaces are usually shared by multiple renters, student housing offers the investor higher returns. It also offers opportunities to generate ancillary income by supplying amenities like parking, bike storage or a gym.

In terms of risk, student rentals have lower default rates than most multi-family units because parents are often the ones to cosign on their kids’ rentals.

Student housing is considered residential, and therefore qualifies for a 27.5-year depreciation schedule, as opposed to industrial and retail real estate, which has a 39-year depreciation schedule. This means there are more deductions to shelter the property income.

Of course there are some disadvantages to consider when you’re thinking of investing in a student rental property. These include lower cash flow in summer months and the high potential for damages. Investors in student housing must also be equipped to deal with an inexperienced renter population and should be prepared to communicate with renters’ parents, who are often involved in the rental process.

To identify lucrative investment opportunities in the student housing market, the investor should stay informed about which universities are growing in enrollment. Higher enrollment means the demand for off-campus housing will increase. A property’s location is an essential factor in assessing the property’s success. Student housing located near a main campus will attract renters more easily than one further away and can demand higher rents. Amenities are important to the student population, with Wi-Fi, gyms, and communal spaces acting as a heavy draw. Lastly, look out for college towns with a stable economy, or an economy that’s on the rise. Colleges and universities in growing towns will look to expand and attract more students – and those students will need housing.

Diversifying your investments to include student housing properties can insulate your investment portfolio from risk and may offer a profitable option for optimizing its value. Speak to your investment advisors to learn more about this promising investment.

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Roth&Co hosted a webinar on February 28, 2024, featuring Tax Controversy Manager Ahron Golding, Esq. The webinar discussed the recent approach that the IRS has been taking towards the Employee Retention Credit (ERC), scrutinizing ERC claims for abuse and fraud. Audits and criminal investigations on promoters and businesses filing questionable claims are intensifying, with thousands of audits already in the pipeline.

What is the IRS looking for? Here is what the IRS refers to as the ‘suspicious seven:’

Too many quarters being claimed

Some promoters have urged employers to claim the ERC for all 7 quarters that the credit was available. Since the IRS believes that it is rare for a business to legitimately qualify for all quarters, making a claim for all of them is a red flag.

Government orders that don’t qualify

In order for a business to qualify for the ERC due to a government order that compromised their operations:

the order must have been in effect for the periods claimed
the order must have been directed towards the business rather than towards the customer
the full or partial shutdown must have been by order and not simply via guidance or recommendation
the IRS is looking for the negative financial impact on the business

Claiming that an entire segment of a business was shut down, though that segment was not significant compared to the entire business, will cause a claim to be disallowed.

Too many employees and wrong ERC calculations

The laws are complex, and have changed throughout 2020 and 2021. Dollar limits, credit amounts, and the definition of qualified wages changed as well. Make sure your calculations are accurate.

Supply chain issues

The IRS is not looking kindly at claims based on general supply chain disruption.

Business claiming the ERC for too much of a tax period

If eligibility is based on full or partial suspension, then a business can only claim the ERC for wages paid during the period of actual suspension, not necessarily the whole quarter.

Business did not pay wages or did not exist during the eligibility period

If the business did not exist or pay any wages during the period of the claim, the claim will be disallowed by the IRS and prosecuted for fraud.

Promoter says there’s nothing to lose

Promoters that urged businesses to claim the ERC because they had “nothing to lose” were mistaken. Incorrectly claiming the ERC invites repayment requirements, penalties, interest, audits, and the expense of hiring someone to help resolve the error, amend returns, and represent the business in an audit.

The IRS has a comprehensive ERC eligibility checklist here.

Many businesses have neglected to take into account the issue of aggregation as it applies to the ERC credit. This can potentially effect employee count, revenue, and other crucial calculations.

Overall, the IRS is not too pleased with ERC promoters. IRS auditors have been trained to start an audit by asking who the taxpayer used to help prepare their claim. The IRS expects a taxpayer to utilize a trusted tax professional, rather than a dubious ‘ERC mill’.

What if the employer has an opinion letter to back up his claim? Generally, opinion letters are only as valuable as the backup data they provide. If a claim can be justified by hard numbers, it will help the employer if challenged.

If a business determines that it incorrectly claimed the Employee Retention Credit, it can use the ERC claim withdrawal process outlined here, so long as the business has not yet received the credit or hasn’t deposited an ERC check. Requesting a withdrawal means a business is asking the IRS not to process their entire adjusted return that included the ERC claim. If the IRS accepts the request, the claim will be treated as if it was never filed.

If a business incorrectly received the ERC before December 21, 2023, and deposited the check, they can apply for the ERC Voluntary Disclosure Program before March 22nd, 2024. This program allows participants to repay only 80% of the ERC they received as a credit on their return or as a refund. Click here for more details.

If your business received an opinion letter regarding ERC eligibility that you would like us to review, please email engage@rothcocpa.com.

This summary has been presented for educational purposes only and does not constitute a comprehensive study of the ERC tax laws or serve as a legal opinion or tax advice.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. In this episode we dive into the 5 major KPIs to consider when investing in the hospitality industry.

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There are five major KPIs, or key performance indicators, that investors in the hospitality industry use to evaluate and compare potential hotel investments:

The Occupancy Rate (OCC)

This measures the percentage of hotel rooms occupied by guests at any given time. The OCC is calculated by dividing the hotel’s occupied rooms by the total number of rooms available. A hotel with a low OCC will need to look for ways to increase room availability in order to remain viable.

The Average Daily Rate (ADR)

The ADR represents the average price guests pay for a room. It’s an important metric because it reveals the price point that guests are willing to pay for a stay at the hotel. The higher the ADR, the better. A growing ADR tells the investor that a hotel is increasing the money it’s making from renting out rooms. To calculate the ADR, the investor takes the total (dollar) amount in room revenue and divides it by the number of occupied rooms

Revenue Per Available Room (RevPAR)

The RevPAR is calculated by dividing a hotel’s total room revenue in a given period by the total number of rooms available in that period. The RevPAR reflects a property’s ability to fill its available rooms and measures how much revenue each rentable room in the hotel generates. A hotel’s RevPAR is particularly useful because it takes into account both the occupancy rate and ADR.

Gross Operating Profit Per Available Room (GOPPAR)

To get a good picture of a hotel’s overall financial performance, an investor might want to look at its GOPPAR. The GOPPAR calculates the revenue from all hotel departments and amenities, then subtracts operating expenses, and divides that by the total number of rentable rooms. GOPPAR is a broad metric; it takes into account all of the property’s revenues – including room revenues and ancillary services, like on-site restaurants or stores.

Market Penetration Index (MPI)

Finally, an investor will want to look at a hotel’s MPI to see how it fairs compared to others in the market. The Market Penetration Index measures a hotel’s occupancy against the average occupancy of its competitors. It helps the investor understand how well a hotel is doing relative to its competitors in a given market. An MPI is calculated by multiplying a hotel’s OCC by its number of available rooms. That number is then divided by the product of the average market occupancy rate and the available rooms in the market.

Remember that no single KPI will reveal the full story about a hotel’s potential. The KPIs are tools that are meant to work together to inform an investor about a hotel’s strengths, weaknesses and commercial possibilities.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. This episode discusses the difference between passive and non-passive income, and why it matters.

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When it comes to a real estate investment, the income generated can be defined as either passive or non-passive.

Passive income refers to income earned from any business activity where the investor does not materially participate in its creation. When a real estate investor invests in a real estate property, but has no substantial, hands-on, active participation in generating its income, that income is defined as ‘passive.’ Passive income comes from money that was invested in a property and was left to generate revenue; the earnings are regarded similarly to earnings from interest, dividends, royalties and bonds, though the tax rates differ.

On the flip side, when an investor materially participates in the day-to-day activities of managing a property – for example, collecting rents, managing tenants, advertising and maintenance – the income he generates is defined as ‘non-passive.’ Some other examples of non-passive income include wages, earnings from active stock trading and earnings from business activity.

Why is the difference between passive and non-passive income relevant?

Because the way your income is categorized impacts how it will be taxed.

Generally, the IRS does not allow a taxpayer to offset passive losses against non-passive income. Passive activity loss rules preclude a real estate owner from deducting losses generated from passive income (i.e. rental income) from non-passive income (i.e. business income).

However, when it comes to taxes, there are always some exceptions to the rule.

If a taxpayer qualifies as a real estate professional, as defined by IRC Sec. 469, the passive activity loss rules do not apply. The investor, or ‘real estate professional,’ can use the losses from real estate activities (like rentals) to offset ordinary and non-passive income.

In another caveat, if a taxpayer owns a piece of real estate and uses it for his own business (i.e. it is “owner occupied”), then real estate loss (passive) can offset the business’ ordinary income (non-passive).

The takeaway? It is essential for a real estate owner to correctly define his income as passive or non-passive in order to enjoy the greatest ROI.

This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for, legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

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School Management Solutions, a Roth&Co affiliate, hosted a webinar yesterday featuring Roth&Co Manager Yisroel Lowinger, CPA , along with Rabbi Yehoshua Pinkus, Director of Yeshiva Services at Agudath Israel of America.

The 30-minute webinar clarified the impact of NYS’ recently released budget for school meal programs. Lowinger discussed what CEP covers, who is eligible, how and when to apply, the anticipated benefits from the new NYS budget, and how summer 2023 will be affected.

Watch the video recap below:

Below are the links which were referenced in the webinar:

CEP Guidance

CEP Application ’23-’24 (direct download link)

CEP Application Instructions

Sample Roster For DCMP (direct download link)

Sample Roster For GoAnywhere (direct download link)

GoAnywhere Access Request Form

With 20+ years’ experience, SMS guides schools in all food and nutrition program needs including application assistance, procurement, program maintenance, compliance and government communications. For further guidance, please reach out to School Management Solutions at info@smsny.net or 718-480-5606.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. This episode discusses a tax-friendly way to maximize your charitable donations – by donating appreciated property.

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Donating appreciated property to a charitable organization that you care about is not only a do-good, feel-good undertaking; it also offers valuable tax benefits. When you sell a real estate property and donate the proceeds, your earnings are subject to capital gains tax. If instead, you donate that same property, you are free from capital gains taxes and the charity gets a higher-value donation. It’s a win-win.

A second benefit is realized when a real estate owner donates appreciated property held longer than one year. Appreciated long-term assets – such as stocks, bonds, mutual funds, or other personal assets like real estate that have appreciated in value – qualifies the donor for a federal income tax charitable deduction. Generally, this deduction is for the full fair market value of the property (or up to 30% of the donor’s adjusted gross income). If the property is held for less than a year, an owner can still benefit by deducting the basis of the property. Since the calculation is based on fair market value, it is highly recommended to get a qualified appraisal on the property so that the donor can substantiate its value if challenged.

What happens if the property is mortgaged? That debt is taken into account when calculating the deduction. The donation of the property is divided into two parts. The portion of the fair market value representing the mortgage is treated as a sale, and the equity portion is treated as a donation. The adjusted basis of the property will be prorated between the portion that is ‘sold’ and the portion that is ‘donated.’ The calculations are often complex, so don’t try this at home! Consult with an experienced tax advisor when donating a mortgaged property for the most accurate computation of your tax benefits.

The double benefits of donating appreciated property – a fair market value deduction and avoidance of the capital gains tax – makes donating to causes you care about both a generous and tax-efficient way to support a charity.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. This episode discusses the difference between holders and developers, and why it makes a difference.

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An identity crisis in the real estate industry can make for costly tax obligations. The real estate industry is diverse and there are many roles to play – investor, agent, broker, developer. Each has its own tax ramifications. Before embarking on the purchase of a property, a buyer needs to ask himself some important questions in order to understand what role he is assuming. What is his business? Is he purchasing a property to hold and profit from as an asset? Is he purchasing a property to develop for sale?

Let’s start with some definitions. A real estate developer is someone who buys land and builds a real estate property on it or buys and improves an existing property. His intent in purchasing is to sell the property for a profit. A developer profits by creating real estate.

A holder or investor purchases a property with a long term intent. He intends to hold the property, rent it out and accrue revenues from it. A holder profits by possessing real estate.

Whether a purchaser defines himself as a holder or a developer is critical because the tax treatment of real estate holders provides certain benefits that are unavailable to developers.

A real estate holder may purchase a property, rent it out, collect income, and when he sells the property, his profit is taxed as a capital gain, as long as he’s held it for more than a year. That means that instead of being subject to the ordinary tax rate he had been paying on his rental income, his income from the sale will be subject to a lower, long term capital gains rate of 15%-20%. Holders are allowed to take advantage of a Section 1031 like-kind exchange to defer the recognition of their gains or losses that would otherwise be recognized at the time of a sale.

Because a holder may be challenged to prove that his intentions were to hold and utilize a property for the long term, it is advisable that he keep good records to support his status. Lease and rental agreements, advertising and listing information, and research efforts should be documented and saved in case his position is challenged by tax authorities after the sale of the property.

For a real estate developer, it’s a whole different picture. A developer is taxed like someone who is running a business that buys and sells real estate inventory. A real estate dealer, or developer, is defined as “an individual who is engaged in the business of selling real estate to customers for gain and profit.” Under this definition, a developer’s income, earned by the sale of his property, would be taxed as an ordinary gain, and taxed at the higher ordinary income rate of up to 37%. He may also be subject to self-employment taxes up to 15.3% (subject to OASDI limitations) as well as city taxes. Developers also cannot depreciate property held as inventory or use a Section 1031 like-kind exchange to defer income recognition. However, they may take advantage of their real estate selling expenses by taking them as ordinary business expenses and deducting unlimited ordinary losses.

Under the IRS Code, each individual property purchased is assessed independently, so one’s status as ‘holder’ or ‘developer’ is not absolute. A real estate entrepreneur may own a portfolio of rental properties which makes him a holder, and may simultaneously purchase and sell other properties, making him a developer as well. His tax status will depend on his intent for that individual property at the time of purchase.

Before purchasing, the savvy investor must be cognizant of his goals and make sure to structure his purchase properly at inception in order to avoid any tax surprises. Consult with your financial advisor regarding newly acquired or potential real estate assets.

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Real Estate Right Now is a video series covering the latest real estate trends and opportunities and how you can make the most of them. Part one of our mini-series on real estate investment through syndication focused on the use of a clause called a ‘waterfall provision.’ We’ll continue with part 2 of our series, which discusses syndication and carried interest.

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A real estate syndicate is an organization, or combination of investors, who pool together capital to invest in real estate. The syndicate shares in the investment’s profits, even though it does not invest any of its own capital. When it realizes a profit, that profit is called a ‘carried interest’ or a ‘promote.’ The carried interest serves as compensation to the syndicator for the risk it assumes during the development of the project and the efforts made prior to its sale.

If a property has been held for more than a year before it’s sold, the carried interest has traditionally been treated as a long term capital gain. This is important because Uncle Sam recognizes a carried interest as a return on investment. So, it’s taxed at a lower capital gains rate than is ordinary income.

However, the IRS later extended that holding period from more than one year to more than three years. Does this paralyze a syndicator for three years, disallowing favorable tax benefits on an earlier sale? Apparently not. On January 13, 2021, the IRS posted final Treasury Regulations for Section 1061 of the Internal Revenue Code. Section 1061 extended the 1-year holding period required for long-term capital gains treatment to a 3-year period for entities termed, “applicable partnership interests” (APIs).

Section 1061(c)(1) defines the term “applicable partnership interest” as “any interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any applicable trade or business.”

There’s an interesting – and potentially profitable – caveat built into the IRS’ definition. Section 1061 rules inadvertently include a favorable exception for real estate investors. After careful review of the updated code, practitioners realized that this new restriction omitted interests resulting from certain services. These services include investing and disposing of real estate held for rental or investment. In our scenario, the syndicate provides these real estate investment services for the investors. This means that a syndicator’s profits at the time a property is sold are the result of an allowable service that, if held for one year, can be treated as a long term capital gain. It is free of the three year holding period requirement and subject to advantageous capital gains tax rates.

Here’s the bottom line: A syndicators’ profits at the time a property is sold will be treated as long term capital gain, free of the three year holding period requirement, and subject to advantageous capital gains tax rates.

Speak to your professional advisor about investing through syndication to build wealth.

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Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co real estate department, this series covers the latest real estate trends and opportunities and how you can make the most of them. Part one of our mini-series on syndication focuses on the use of a clause called a ‘waterfall provision.’

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A real estate syndicate is formed when an individual, partnership or organization pools together outside capital and invests in real estate. The syndicator will do all the groundwork on behalf of the investors, or “partners”, and will research, locate, purchase and eventually manage the investment property. Although the syndicator puts in sweat equity, it doesn’t invest any of its own capital.

There are several ways that a syndicator can share in the investment’s profits, and the role that each player assumes in the real estate transaction will determine its share. Those roles are explained in the “waterfall provision” found in their partnership agreement.

A ‘waterfall,’ also known as a waterfall ‘model’ or ‘structure,’ is a legal term that appears in a partnership’s operating agreement that describes how and to whom distributions are made. The property’s profits from operations, or from a “capital event” (i.e. refinance or sale), are allocated to the investors based on the terms of the waterfall provision. In the example in our video, the investors agree to contribute $2 million towards the property’s purchase. They make it a 70%/30% split and decide on an 8% “preferred return” on their $2 million capital investment.

Here’s how it will play out: The syndicator keeps an accounting of the property’s cash flow over the course of their ownership and will wait until the investors have been satisfied as specified in the waterfall agreement. In our example, the agreement ensures that the investors earn 8% of their capital investment – that would be $160,000, or 8% in preferred returns – and recoup their original $2 million investment. The syndicator will benefit from the profits of the operation, or its sale or refinance, only after the investors have recouped $2,160,000, (the amount of their capital investment and preferred returns). When the terms are satisfied, the syndicator will earn its 30% share of any residual profits, and the remaining 70% will be shared among the investors. It’s a win-win.

When distributions are made based on the profits of a property’s operations, it results in steady payments over the life of the property. However, it’s very common, and often very profitable, for an ‘event’ to accelerate the waterfall process. If the property is sold or refinanced, profits are actualized quickly and monies are released for distribution quickly. In either case, real estate investment by syndication offers an investment model that can benefit investors at many levels and presents profitable opportunities for syndicators and non-real estate professionals alike.

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Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, this series covers the latest real estate trends and opportunities and how you can make the most of them. This episode discusses how the tax-deferred benefits resulting from a 1031 exchange can help investors build a more valuable real estate investment portfolio.

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What is a 1031 exchange?

In 1921, Section 1031 was entered in the US Internal Revenue Code and the ‘1031 exchange’ was born. Under specific criteria, a 1031 exchange allows an investor to sell his property, reinvest in a similar property of equal or greater value, and defer payment of capital gains taxes until that second property is ultimately sold.

Eligibility for a 1031 exchange is reserved for real property that is “held for productive use in a trade or business or for investment”. This kind of property could include an apartment building, a vacant lot, a commercial building, or even a single-family residence. Properties held primarily for personal use do not qualify for tax-deferral under Section 1031. There are specific types of property that don’t qualify for a 1031 exchange, including business inventory, stocks and bonds, securities and partnership interests.

Your reinvested property must be “like kind,” or of the same nature, as the property being replaced. The definition of “like kind” is fairly loose, and IRS considers real estate property to be like-kind regardless of if or how that property has been improved.

Benefits

The obvious benefit of a 1031 exchange is that you get to hold onto your money for longer and have more funds available to take advantage of other investment opportunities. A 1031 exchange could also yield tax-shielding benefits, such as depreciation and expense deductions and capital returns at a refinance. A 1031 exchange is also useful for estate tax planning. Tax liabilities end with death, so if you die without selling a property that was invested through a 1031 exchange, your capital gains tax debt disappears. Not only that, but your heirs will inherit the property at a stepped-up market-rate value.

Details and Dangers

A 1031 Exchange has a very strict timeline. The replacement property, which must be of equal or greater value, and must be identified within 45 days. The replacement property must be purchased within 180 days. One potential pitfall investors face when deciding to implement a 1031 Exchange is that, because of the time pressure, they may rush to commit to an investment choice that is less than worthwhile. For that reason, potential investors are advised to plan ahead when considering a 1031 exchange. In order to get the best deal on a replacement property, don’t wait until the original property has been sold before starting to research replacement options.

45-Day Rule

When an investor sells his property and chooses to do a 1031 Exchange, the proceeds of the sale go directly to a qualified intermediary (QI). The QI holds the funds from the sold property and uses them to purchase the replacement property. As per IRS 1031 rules, the property holder never actually handles the funds. Also within the “45 day rule”, the property holder must designate the replacement property in writing to the intermediary. The IRS allows the designation of three potential properties, as long as one of them is eventually purchased.

180-Day Rule

The second timing rule in a 1031 is that the seller must close on the new property within 180 days of the sale of the original property. The two time periods run concurrently, so for example, if you designate a replacement property exactly 45 days after your sale, you’ll have only 135 days left to close on it. To determine the 180-day time frame, the IRS counts each individual day, including weekends and holidays.

1031 Exchange Tax Implications

What happens when the purchase price of your replacement property is less than the proceeds of the sale of your original property? That cash – known as the “cash boot” – will be returned to you after the closing on the replacement property, but it will be considered as sales proceeds and taxed as a capital gain.

Another important factor to remember is that if you have a mortgage, loan or other debt associated with the exchange, and your liability goes down, that sum will also be treated as income. For example, if you had a mortgage of $1 million on your original property, but your mortgage on the replacement property is only $900,000, you will enjoy a $100,000 gain. That $100,000 is the “mortgage boot”, and it will be taxed.

The 1031 Exchange is a tax-deferred strategy that any United States taxpayer can use. It allows equity from one real estate investment to roll into another and defers capital gains taxes. It’s like having an interest free loan, compliments of the IRS. Savvy investors can put that extra capital to work and acquire a more valuable investment property, painlessly building wealth over time. Over the long term, consistent and proper use of a 1031 Exchange strategy can provide substantial advantages for both small and large investors.

This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

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Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, this series covers the latest real estate trends and opportunities and how you can make the most of them. This last episode in our valuation metrics mini-series discusses one final metric: Discounted Cash Flow.

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DCF, or Discounted Cash Flow, is used to determine the total monetary value of an asset in today’s dollars and is a powerful tool for valuing businesses, real estate investments or other investments that project to generate profits and cash flow.

DCF studies a potential investment’s projected future income and then discounts that cash flow to arrive at a present, or current, value. It adds up the property’s future cash flow from the time of purchase until the time of its sale and all the activity that happens in between. It takes into account the property’s initial cost, annual cost, estimated income, operating costs, renovations, changes in occupancy and its future selling price, among other factors. At the end of the assumed investment period, an exit price is determined using the building’s metrics in the year of disposition. The entire cash flow stream, including the forecasted profit from the investment’s sale, is then discounted back to the current period using a discount rate.

The discount rate represents the rate of return that is required of the investment based on its risk. The higher the risk, the higher the return required by the investor, and the more we have to discount the investment’s value. A higher discount rate implies greater uncertainty, and that means a lower present value of our future cash flow. On the flip side, the lower the perceived risk in an investment, the lower the discount rate.

The DCF metric is an influential tool, but it has its drawbacks. The upside of the DCF model is that it is very customizable and able to be tailored to the facts and circumstances, such as projected renovation costs or market changes. The downside is that the model is very sensitive to changes in its variables. For example, a change in the discount rate of less than 1% can have a 10% effect on the value of the investment. There is a lot of assumption and estimation involved, and small changes can have a big impact on the end-result.

Whereas it may not always be accurate or applicable for every situation, the DCF calculation remains a formidable tool in the investors’ arsenal and, combined with other important metrics, allows the investor to assess the present value, risk and potential profitability of a real estate investment.

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Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, this series covers the latest real estate trends and opportunities and how you can make the most of them. This episode discusses more critical valuation metrics used to calculate the potential of an investment property.

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In our last video we talked about three useful tools to help calculate the potential of an investment property: GRM (Gross Rent Multiplier), PPU (Price Per Unit) and Cap Rate (Capitalization Rate). Moving forward, here are additional metrics that can help an investor dig even deeper.

IRR

The Internal Rate of Return (IRR) is a metric used in financial analysis to estimate the profitability of a potential investment. It represents the annual rate of return on your investment, over the life of that investment. The higher the IRR, the healthier the return.

The IRR is calculated by computing the net present value of the investment. The Net Present Value (NPV) is the amount that the investment is worth in today’s money. To successfully analyze the data, future values must be considered against today’s values. Why? Because today’s money is more valuable than the value of the same money later on. This is also known as the time value of money.

When we calculate the IRR, we solve for “a rate”, so that the Net Present Value of the cash outflows and inflows is zero. That “rate” is the IRR. We achieve this by plugging in different interest rates into our IRR formula until we figure out which interest rate delivers an NPV closest to zero. Computing the Internal Rate of Return may require estimating the NPV for several different interest rates. The formulas are complex, but Microsoft Excel offers powerful functions for computing internal return of return, as do many financial calculators.

Simplified, here is how it works:

If you invest $10,000 in year one and receive an $800 return annually through Year 5, then exit the investment for $15,000, you would calculate the IRR as follows:

This scenario yields an IRR of 18%.

Here’s a similar scenario that yields a different result:

This scenario yields an IRR of 15%

Which scenario provides a better return? Looking at the bottom line is deceptive. By calculating the IRR for both investments, you would see that the IRR on the second investment, 15%, is a nice return. However, the first investment, with an 18% IRR, would be a better use of your money.

CoC Return

The Cash-on-Cash Return tells the investor how much cash the investment will yield relative to the cash invested. It measures the annual return the investor made on a property after satisfying all debt service and operating costs. This is a helpful analytic for many real estate investors who commonly leverage investments by taking out mortgages to reduce their cash outlay. The metric is the most helpful when liquidity during the investment period is important to the investor. One of the most important reasons to invest in rental properties is cash flow, and Cash-on-Cash return measures just that. Put simply, Cash-on-Cash return measures the annual return the investor made on the property after satisfying all debt service and operating costs.

Here is a simple CoC Return example:

Let’s say you buy a multifamily property for $200,000, putting down a $40,000 deposit, and assuming a $160,000 mortgage. Your gross rents are $30,000 monthly, with $20,000 of operating expenses. Additionally, you have $9,000 monthly debt service payment comprised of $7,000 interest and $2,000 principal. Because principal payments are not an expense, Net income is $3,000 annually.

However, when calculating Cash-on-Cash, you consider the debt service as well, bringing your return to $1,000 monthly, or $12,000 annually.

Comparing your investment’s yearly net income of $12,000 to the $40,000 down payment, you have a Cash-on-Cash annual return of 30%. While there is no specific rule of thumb for what constitutes a good return rate, the general consensus amongst investors is that a projected Cash-on-Cash return between 8% to 12% implies a worthwhile investment.

Financial metrics are important and useful tools that can help an investor make smart, informed decisions. Whereas any one metric may have limitations, by considering a combination of metrics commonly used for comparing, in addition to tracking performance or value, an investor can target a strategy and analyze risk in a potential investment opportunity.

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Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, this series covers the latest real estate trends and opportunities and how you can make the most of them. This episode discusses critical valuation metrics used to calculate the potential of an investment property.

Watch our short video:

Investing in real estate can be profitable, rewarding and successful. At the same time, the real estate investment industry is also demanding, competitive and very often, risky. Success requires a combination of knowledge, organization and determination, and while this article may not be able to supply some of those requirements, it will help increase your knowledge about how to initially assess a real estate investment. Here are three useful tools to help calculate the potential of an investment property:

o Gross Rent Multiplier (GRM)
o Price Per Unit (PPU)
o Capitalization Rate (Cap Rate)

Gross Rent Multiplier (GRM)
When an investor considers buying a commercial or rental property, he’ll need to know how long it will take to earn back his investment. The GRM is a simple calculation that tells us how many years of rent it will take to pay off the cost of an investment purchase. The GRM formula compares a property’s fair market value (the price of the property) to its gross rental income.

Gross Rent Multiplier = Purchase Price / Gross Annual Rental Income

The result of the calculation represents how many years it will take for the investor to recoup the money he spent on the purchase of the property. The lower the gross rent multiplier, the sooner the investor can expect to get his money back.

Calculating an investment property’s GRM is not complex and will result in a useful metric, but in practicality, it does not consider operating costs such as the debt service coverage, the property’s maintenance expenses, taxes, local property values and other important factors that strongly impact the profitability of an investment
Experienced investors use the GRM metric to make quick assessments of their opportunities, and to quickly weed through their options. A high GRM may serve as a red flag, directing the investor to look elsewhere and spend more time analyzing more optimal options.

Price Per Unit (PPU)
Another tool in the investment arsenal is the PPU, or Price Per Unit. This calculates just that – the price per door on your investment property. The calculation is simple:

Price Per Unit = Purchase Price / Number of Units

In other words, the PPU is the amount the seller is asking per unit in the building. The PPU can provide a broad view of the market and can give you a good idea of how one property compares to another. The downside of the calculation is that it does not determine the ROI or Return on Investment. PPU does not take any other features of the property into consideration, so its usefulness is limited.

Capitalization Rate (Cap Rate)
The Cap Rate is a realistic tool that considers an investment’s operating expenses and income, and then calculates its potential rate of return (as opposed to the GRM, which looks only at gross income). The higher the Cap Rate, the better it is for the investor. Why is it realistic? Because the Cap Rate estimates how profitable an income property will be, relative to its purchase price, including its operational expenses in the computation.

Capitalization Rate = Net Operating Income / Purchase Price

Like any other calculation, the Cap Rate will only be as accurate as the numbers applied. If a potential investor under- or overestimates the property’s operational costs or other factors, the calculated Cap Rate won’t be accurate.

There is no one-size-fits-all calculation that will direct an investor to real estate heaven. However, utilizing basic tools like the GRM, PPU and Cap Rate will give an investor a broad view of the investment’s potential. Using these tools to jumpstart the due diligence process can help the investor determine whether further research into the investment is warranted and what a property’s potential for profit may be.

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Roth&Co’s latest video series: Real Estate Right Now. Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, will cover the latest real estate trends and opportunities and how you can make the most of them. This episode discusses real estate professionals.

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REAL ESTATE PROFESSIONALS IN DETAIL:

Qualifying as a real estate professional potentially allows a taxpayer to deduct 100% of all real estate losses against ordinary income. It also helps the taxpayer avoid the 3.8% Section 1411 net investment income tax on qualifying rental property income.

For many real estate businesspeople, especially those who own several rental properties, acquiring Real Estate Professional status can create thousands of dollars in tax deductions resulting in a zero tax liability at the end of the year.

How does one qualify as a Real Estate Professional?

Under the IRS’s Section 469(c)(7)(B), one can qualify as a real estate professional if two conditions are met:

The taxpayer must prove that he or she spends more time “materially participating” in real estate activities than in non-real estate activities.
The taxpayer must spend at least 750 hours per year “materially participating” in real estate activities

Material Participation

The IRS wants to know that the taxpayer is active in real estate activity and is not a passive investor. A taxpayer can try to establish material participation by satisfying any one of the seven tests provided in IRS Publication 925. The taxpayer may elect to aggregate all of his or her interests in rental real estate to establish material participation.

Passive or Non-Passive Income?

According to the IRS, non-passive income is money that you actually work for. It’s generally reported as W-2 or 1099 wages. Passive income is the money you earn without any particular labor, like interest, dividends…and rental income.

IRS Code Section 469 defines all rental activities, regardless of the taxpayer’s level of participation, as passive activity; and the taxpayer may only offset losses from a passive activity against income from a passive activity.

However, Section 469(c)(7) was later added to the law to avoid unfair treatment to those actually participating in the business of renting, selling or developing real estate. This provision provides an exception for ‘qualifying real estate professionals’ and allows them to treat rental activities as non-passive.

So, the rental activity of a taxpayer who qualifies as a real estate professional under Section 469(c)(7) is not presumed to be passive and will be treated as non-passive if the taxpayer materially participates in the activity.

Bottom line? As a qualified real estate professional, one can deduct of rental losses against his or her non-passive income.

Qualifying as a real estate professional can also be advantageous to taxpayers with rental income. A net investment income tax imposed in Section 1411 levies an additional 3.8% surtax on, among other matters of investment income, all passive income of a taxpayer. A taxpayer who qualifies as a real estate professional with rental income may choose to represent that rental income as non-passive and may be able to avoid this 3.8% surtax.

Does your business activity define you as a Qualified Real Estate Professional? Contact us for advice on how to take advantage of this significant status and how to minimize your real estate tax burden.

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COST SEGREGATION IN DETAIL:

What is cost segregation?

From a tax perspective, there are two types of property that depreciate differently:

Real Property: Actual buildings or structures that can be depreciated over 27.5 or 39 years.

Personal property: Furniture and fixtures, equipment and machinery, carpeting, electrical wiring and window treatments that can be depreciated over 5, 7, or 15 years.

As assets depreciate, their value decreases, reducing federal and state income taxes on their rental income.

Cost-segregation is an IRS-approved federal tax planning tool that allows companies and individuals who have purchased, constructed, expanded or renovated any kind of real estate to accelerate depreciation by reclassifying specific assets from real property to personal property reducing the federal and state income taxes owed.

How does it work?

A cost segregation study is required to breakdown commercial buildings into assets that could be reclassified as personal property. The cost segregation study provides real estate owners with information required to calculate the accelerated depreciation deductions for income tax purposes. The cost segregation study will also serve as the supporting documentation during any IRS audit.

On average, 20% to 40% of components fall into the personal property categories that can be written off much quicker than the building structure.

How much does a cost segregation study cost?

Cost segregation studies generally run between $5,000 – $20,000.

What properties are eligible?

Any commercial property placed into service after 1986, including any new acquisition, real estate construction, building, or improvements may qualify for a cost segregation study. Examples of eligible buildings include retail centers, office and industrial buildings, car dealerships, medical offices, multi-family unit buildings, restaurants, manufacturing facilities, and hotels.

When is the best time to conduct a cost segregation study?

Cost segregation studies may be conducted after a building has been purchased, built, or remodeled. However, the ideal time to perform a study is generally within the first year after the building is placed into service to maximize depreciation deductions as soon as possible.

Can I utilize cost segregation if my property is already in use?

Yes! A cost segregation study performed on a property in use and a tax return has been filed, is known as a look-back study.

You can then apply a “catch-up” deduction, which is equal to the difference between what was depreciated and what could have been depreciated if a cost segregation study was performed on day one.

The IRS allows taxpayers to use a cost segregation study to adjust depreciation on properties placed in service as far back as January 1, 1987.

Properties already in service are often overlooked when it comes to cost segregation, however the benefits of a look-back study can be quite significant.

What changed?

The Tax Cuts & Jobs Act passed in 2017 introduced the “100% additional first year depreciation deduction” otherwise known as “bonus depreciation” that allows businesses to write off the cost of most personal property in the year they are placed in service by the business. The bonus deduction is eligible until 2023.

What are other factors do I need to consider before claiming a depreciation deduction or bonus depreciation?

Active vs Passive Partners: Active partners can use the deduction to offset ordinary income. Passive partners can only use the deduction to offset passive income.

State Tax: The bonus depreciation deduction may only apply to federal income tax. Check with your state to see if they apply to state taxes as well.

President Joe Biden promised the end of many tax cuts. Could this be one of them?

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Roth&Co Partners and staff reflect on the firm’s journey over the last 40 years.

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Zacharia Waxler, Co-Managing Partner at Roth&Co, identifies the differences between a company’s strategy and its culture, and discusses the importance of focusing on both.

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oth&Co Tax Attorney Ahron Golding, discusses the importance of using an effective method of accounting, and the problem with using the “Ostrich Method,” which involves burying your head in the sand and hoping the IRS will go away.

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Heshy Katz, Partner at Roth&Co, discusses the importance of innovation in business. He explains how a lack of vision can lead any business to the same fate as Kodak, while constant innovation can lead to incredible gains and profit.