September 2022 | Clear Insights | Accounting Memorandum

By Chris Serna | Education

By Angelina Penny, Patti Richardson, Paul Pellizzon, Samantha Maynard, Tyler Stoll

Losses Generated by our Offerings

Our LLCs have historically generated cash flow by way of quarterly distributions,while also producing tax losses. This ideal scenario is mainly driven by the depreciation benefit that comes with investing in rental real estate.

Losses from our investments can generally offset passive income you might have from other investments. To the extent passive losses exceed your passive gains, they are carried forward indefinitely for potential use in future years. Additionally, depending on your personal tax situation and status as a real estate professional, passive losses may be able to offset some of your ordinary income.

Cost Segregation

Clear Capital engages firms to conduct cost segregation studies on our properties, with the goal of reclassifying assets from “building”, which has a depreciable life of 27.5 years for rental real estate, to assets with shorter depreciable life, such as furniture, flooring, roofing, asphalt, etc.

Recategorizing to a shorter depreciable life means that our investors receive larger depreciation expenses earlier in the property business plan. This is all non-cash expenses, of course, and this does not diminish a property’s ability to make distributions. It does however decrease the taxable income or increase the taxable loss the property generates and passes along to investors. Cost segregation is a key component to real estate investments because of the time value of tax losses it provides to investors.

1031 Exchanges

A like-kind exchange, colloquially known as a “1031 exchange” is a method of tax-deferral. A 1031 exchange involves selling a property and reinvesting the proceeds into a like-kind property.

Clear Capital generally utilizes 1031 exchanges to minimize investor tax burden. To execute a 1031 exchange, all proceeds from the sale of property must go to a third party, called an “intermediary”. Clear Capital has 45 days from sale to identify three potential properties that we may exchange into. There are a couple other accepted mechanisms to identify exchange property, but this is the most common and Clear Capital’s preferred method. Within 180 days of sale, we must close escrow on the replacement property(s). Leftover cash that is not reinvested, known as boot, will be taxed as capital gains.

The IRS rules to determine gain recognition (if any) for 1031 exchanges are complicated, but the replacement property’s purchase price and mortgage determine the amount of capital gain deferral.

As always, the entire Clear Capital team thanks you for your continued trust and confidence in our team, and we wish you well on your investing journey and beyond.