Tax Implications for the Real Estate Crowdfunding Investor

Its Tax time! That dreaded time of the year for everyone, but especially for real estate crowdfunding investors. I’ve competed my own taxes for over 30 years and I’ve used TurboTax for the last 15+ years. After spending a mind-numbing week entering close to 100 K1’s into Turbo Tax and trying to determine which states to file a nonresident return, I have given up.  Next year a cpa will take over this chore.

With less than a week to go, I am missing 4 K1’s. I will have to file an extension. I used to think Turbo Tax was simple to use.  With Stock and bonds, it’s gotten easier. You give Turbo Tax your log in credentials and they download all the transactions and dividends.  Easy breezy if the purchases were within the last few years.  You still must enter older purchases by hand.  This is reason number one, I am giving up on Turbo Tax.  I invest with Wealthfront and they made over 1000 free trades in my account and generated over $30,000 in short term losses while the account’s value went up over 10%. That’s the good news, the bad news is 53 transactions did not download the purchase price.  The only way to get that data into TurboTax was manually. My tax return is over 600 pages and each change requires TurboTax to think for over 60 seconds.  This was a painful process.

The second issue for dumping Turbo Tax is nonresident tax returns.  First, I had to determine which states had over $1000 in state specific income.  I made an excel spreadsheet and entered K1 information from over 20 K1’s and 10+ states.  Once I determined the states to file is when the trouble began.  There is nothing, I repeat nothing intuitive about entering K1 data into TurboTax for a nonresident tax return.  In addition, TurboTax ask questions and the answers are not on the K1’s. After 4 or 5 hours trying to determine what Turbo tax meant by this or that, I punted.  If WV thinks I owe tax, it will not be much and I will gladly pay any penalty.

Another ugly truth about K1’s is some are not accurate.  All accountants are not created equally and some are just plain awful.  One Realty Shares K1 was a carbon copy of 2015’s K1.  This is impossible because the property was sold in 2015 and the only activity in 2016 was the final distributions.  After 3 phone calls and 5+ emails, the K1 was changed.  I never got a notification that the K1 was updated. If I had not manually checked to see if it was changed, I would have over reported my income by $18,000.  I wonder if other investors in this deal caught the mistake.

The good news from my 100 or so K1’s was the awesome tax benefit.  So far for every $100k in distributions, my taxable income (box 1 and box 2) was -$30,000 and my long-term capital gain was $35,000.  Doing the quick and dirty math, that’s pretty much $100,000 tax free in cash flow.  The word “Tax Free” is not accurate.  Its tax deferred.  Some of the benefit of depreciation will get reversed once the assets are sold.  For example, one K1 had a net loss of $25,000 in Box 2, but had a distribution of $3,000.  Contrast this to my debt investments and for every $10,000 in distributions, $10,0000 in ordinary interest income was reported to the IRS.  At a top tax bracket with state income tax, over 40% of that goes to Uncle Sam. Investing in Equity is riskier than debt.  However, I prefer its higher returns and short term tax benefits.