If you are a real estate investor, you have no doubt heard about the benefits associated with crowdfunding real estate deals. It’s not hard to see how the system is setup to benefit investors and entrepreneurs. It provides easy access to investors who can provide the capital you need to make your next project work, and it also provides a framework for repayment that is easy to understand and manage, which would not have been possible when dealing with a large number of investors even fifteen years ago. This makes crowdfunding for real estate very efficient and easy to manage for even smaller investors.
If you are interested in backing real estate projects, crowdfunding platforms provide you with an easy way to connect to developers with investment opportunities. Crowdfunding is relatively easy to participate in, too. Investors simply sign into the crowdfunding platform to navigate through various projects. The research about the property development and the prospectus are available, and there are usually various levels of involvement with projected investment returns. There are certain platforms that provide a means for developers to independently present opportunities. In this case, the platform provides a variety of tools and features to customize the offering, including the returns being offered. Other platforms will work directly with the developer as the direct financing partner. These platforms will be responsible for presenting the investment offering to prospective investors.
During the crowdfunding period, investors buy into the project for various amounts, securing their portion of the investment. One needs to understand the project’s terms and the ways they work to understand the tax implications of investing. That’s because the structure of the crowdfunding real estate opportunity and the exact rules of the platform can affect the way you realize the gain from your investment, changes to the way you get paid and affects the way you report that gain for tax purposes. A number of factors determine how you need to report income taxes, so it is important to consider all of them before investing.
Here are the major aspects you need to consider as you plan your first crowdfunding real estate investment. It’s vital to know all of this before committing to any deal because your tax planning and income management are going to depend on it.
Is this an equity arrangement or are you financing a loan? The income from them is vastly different, both in the timing of its delivery and in its size. Depending on your platform, you might see interest payments every quarter or every month throughout the payment period if you are backing a loan. These earnings represent income from the interest that is paid on the loan and your original investment amount – the principal – will be returned at the end of the loan period. If it is an equity deal, though, then you are unlikely to see any income until the property is sold or until it begins to lease to tenants, depending again on the nature of the investment. If the property is sold, you can plan on a lump sum in one tax year. If you receive interest, then you will have a smaller tax burden each year, but you will have to plan on paying taxes on the investment every year.
Schedule K-1 is the income reporting schedule used to report partnership income, and it is filed by each partner. Some people wonder whether or not this is the proper way to report income from crowdfunding investments. The answer is that it is, under the right circumstances. If you enter into a formal business partnership with other investors and then back a project, you would report your portion of the partnership income on a K-1 form.
Generally speaking though, when you buy into a crowdfunded investment, it isn’t like forming a partnership with friends or family and investing together. It’s more like you purchase shares of a loan, and then you receive a payoff in the form of interest earnings paid regularly over time, and a lump sum of your initial investment amount when the loan is repaid. That interest income would be reported as general income on a 1099-INT form, similarly to the way you would report other investment income.
Individual retirement accounts can be used for investment purposes if you wish, and the taxes are deferred until the money is withdrawn at retirement. The benefit of a SD-IRA is that you can invest in many opportunities, such as crowdfunding or private equity, that are not available to normal retirement accounts, like a 401K or a regular IRA. The downsides are multiple, but they are often worth the trouble for investors:
Each IRA, even those that are self-directed, must be held by a custodian. This can either be a credit union, bank, trust company or a licensed non-bank custodian. Taking time to research and ask questions when looking for a custodian is one of the ways you can get the most benefit from your investment.
The advantages are almost limitless, though, because by self-directing your IRA investment, you can put your money into the investments you choose, allowing you to grow your money as quickly as your skill lets you.
Take some time to learn all about the tax implications of real estate crowdfunding in our free eBook before you start investing.