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What are the tax implications of my investment?

Real estate investing is the best kept tax secret that hides in plain sight.
Real estate investing is the best kept tax secret that hides in plain sight.
tax implications of real estate investments
tax implications of real estate investments

This is especially important for physicians, who are some of the most highly taxed professionals in America. When it comes to taxation, sometimes it feels like doctors are at a disadvantage at every stage of their careers.


The time spent becoming a doctor is time not spent earning, saving and investing. Usually, it is a time of taking on yet more debt—debt that isn’t tax deductible. And once physicians have an income, they are taxed heavily and must repay their debt with remaining funds. The cost of tuition, the length of training and the impact of mostly earning salaried income all carry a long-term tax burden that chips away at wealth.


Given the way most healthcare professionals earn their incomes, understanding which real estate tax investing benefits are available is one of the best ways that real estate investors can achieve actual wealth and mitigate their tax burden.


In fact, real estate may be the only investment category where physicians are helped by the complexities of the tax code. Even then, this is only true if they are working with the right real estate partners who know how to maximize the returns of real estate investments.


The IRS provides a few tax options that can work in the real estate investor’s favor, making real estate an ideal vehicle for physicians looking to build wealth and still mitigate taxes.


First, the “1031 Exchange,” which sounds like a 1970s sci-fi movie title, in fact refers to Section 1031 of the U.S. Internal Revenue Code. This handy provision allows investors to avoid paying capital gains taxes on the sale of an investment property, as long the proceeds are reinvested within certain time limits in a property or properties of equal or greater value.


Simply put, a 1031 exchange allows you to defer paying capital gains taxes and depreciation recapture. Think of it like a money manager buying and selling stocks in your 401(k) mutual fund.


Time plays a significant role in the 1031 exchange. After you have sold your property, you have around 45 days to find replacement properties. After that, you have 180 days to complete the purchase of those properties. 


If done correctly, a 1031 exchange can be a way for your heirs to avoid paying any deferred taxes upon your death. Rather than placing real estate into a trust, you can continue performing 1031 exchanges until your death. Your heirs will receive the property on a stepped-up basis, which means that the property will be treated as if its value is its fair market value at the time of death and not have to pay any deferred taxes. However, your heirs may have to pay estate taxes, so they should consult an estate lawyer.


Second, when income is realized, your accountant will need to file a Schedule K-1 with your taxes. This is akin to a 1099 or W-2 but captures the income you receive from your Ballard investments. Within Ballard’s deal structures, you are a partner in either our fund or in a specific deal. As a partner or shareholder, all dividends, deductions, gains, and losses are reported on the K-1. These are calculated based on each partner’s or shareholder’s basis—your percentage of ownership or investment—in the business.


In the case of a partnership where one or more partners receive guaranteed payments, the guaranteed payments are also reported on the partners’ K-1s. And a capital account analysis for each partner, or percentage of stock ownership for each shareholder, is included on the K-1.


This sounds straightforward enough, but it harbors a specific advantage for real estate investors. The U.S. tax code allows the use of certain pass-through taxation for such investments, which means that 100% of income and expenses flow through the partnership to the owners or partners. This is good for tax purposes because the tax deferral, tax shields, and the favorable capital gains rate paid at sale benefit real estate investors.


The K-1 also captures the accelerated depreciation deductions allowed by the IRS with regard to rental real estate. While property usually increases in market value each year, the cost to purchase residential real estate can be written-off as depreciation over a 27.5-year life, providing a substantial benefit to the investor.


Summing up, maximizing the tangible benefits in the tax code for real estate investors requires a partner who invests with discernment, ensuring your portfolio yields both the greatest appreciation and the greatest tax benefit