Episode 15: Passive Loss Carryforwards - Your Secret Tax Weapon

Welcome to Building Passive Income, the podcast for professionals, entrepreneurs and investors who want to build wealth, diversify beyond Wall street, and create true financial freedom through passive commercial real estate investing. I'm Wayne Courageous III, founding and managing principal of Crei Partners, a leading commercial real estate company. I created CreiColin, an AI powered resource to serve as your investor education guide. Built on the insights and experience we've developed at Crei Partners, CreiCollen is here to educate you through passive invest tax strategy topics to help your journey in passive investing. Just a quick disclaimer. This podcast and CRA Colin is for educational purposes only and is not legal tax or investment advice. Always consult with your attorney, CPA and financial advisor before making any investment decisions. I've spent nearly two decades helping investors understand the power of commercial real estate from multifamily to storage to retail. Each episode is under 15 minutes, simple to follow and and packed with insights to help you grow your income and protect your capital without becoming a landlord. If you're ready to learn quickly and invest smarter, you're in the right place. Welcome to Building Passive Income. Let's build wealth together. Here's creicollen.

Most investors think tax benefits only matter in the year you take them. They're wrong. I'm Crei Colin and this is Building Passive Income, where we give you the strategies to build real wealth through passive real estate investing. Today, we're talking about passive loss carryforwards, one of the most underrated and misunderstood tax strategies in real estate investing. If you understand how to build, track and deploy passive loss carryforwards, you can offset passive income for decades. Let's dive in. First, let's make sure we understand what passive loss carryforwards are. When you invest in a real estate syndication, you typically receive depreciation and other deductions that create a passive loss on your tax return. For example, you invest $100,000 into a multi family deal and in year one you receive a $30,000 passive loss from depreciation. Now here's the As a passive investor, you can only use passive losses to offset passive income. You can't use them to offset your W2 income or business income unless you qualify as a real estate professional under IRS rules, which we'll talk about in a future episode. So if you have 30,000 in passive losses but no passive income in year one, you can't use the loss that year. But here's the key. The loss doesn't disappear. It carries forward indefinitely until you have passive income to offset, or until you sell the investment. That's a passive loss carryforward. And it's one of the most powerful tools in your tax arsenal. Here's why passive loss carryforwards are so powerful. They accumulate over time and you can deploy them strategically to offset passive income in future years. Let's walk through an example. You invest in three syndications over three years. Each one generates 30,000 in passive losses in year one. Due to cost segregation and bonus depreciation. You have no passive income during those three years. So the losses carry forward. By year three, you have 90,000 in passive loss carryforwards sitting on your tax return. Now in year four, those three syndications start stabilizing and generating cash flow. Let's say they collectively generate 20,000 in passive income. You can use your 90,000 in carryforwards to offset that income completely. That's tax free cash flow. In year five, let's say you sell one of the syndications and realize a 150,000 capital gain. That gain is passive income. You can use your remaining carryforwards seventy thousand at this point to offset a big chunk of that gain, reducing your tax bill significantly. This is the beautiful cycle. You build passive losses in the early years through depreciation and you deploy them in later years to offset passive income and capital gains. It's a long term strategic approach to tax efficient wealth building. Now let's talk about the beautiful cycle in more detail. Because this is the framework I use and, and the framework I teach to every investor I work with. The beautiful cycle has four accumulation, cash flow, exit and reinvestment and financial independence. Phase one accumulation. This is years one through five of your investing journey. You're deploying capital into syndications, building a diversified portfolio and accumulating passive loss carryforwards through depreciation. During this phase, you're typically not seeing a lot of cash flow yet, but you're building a massive tax shield for the future cash flow. This is years 5 through 10. Your syndications are stabilized and they're generating consistent cash flow. You're using your accumulated passive loss carryforwards to offset that income. So you're receiving tax free or tax reduced distributions. Exit and reinvestment. This is years 10 through 20. Your syndications are starting to sell and and you're realizing capital gains. But because you've built up significant passive loss carryforwards over the years, you can offset a large portion of those gains. You then reinvest the proceeds into new deals, potentially using 1031 exchanges or qualified opportunity zones. To defer even more taxes. Phase four, financial independence. This is year 20 and beyond. You have a mature, diversified portfolio generating consistent cash flow. You've used your passive loss carryforwards strategically over the years and you're now living off tax efficient passive income. You're financially independent. This is the long game. This is wealth building with intention. And it all starts with understanding and tracking your passive loss carryforwards. Here's the critical part. You have to track your passive loss carryforwards every single year. And your CPA has to track them too. Every year. When you file your tax return, your CPA should provide you with a summary of your passive loss carryforwards by property. You should know exactly how much you have in carryforwards, which properties they're from, and how much you've used each year. If your CPA isn't doing this, that's a problem. Go back and listen to episode six where taxpro Tina talks about finding a real estate CPA who understands this stuff. Here's what I do. I keep a spreadsheet that tracks every syndication I'm invested in, the passive losses I receive each year, and my cumulative carryforwards. I update it every year after I file my taxes. This gives me a clear picture of my tax position and helps me plan future investments. Let me give you a real world example of how this plays out. Let's say you're a high income W2 earner making 400,000 a year. You invest 100,000 per year into syndications for five years. Each deal does cost segregation, so you receive an average of 30,000 in passive losses per deal. In year one. After five years, you've invested 500,000 and you've accumulated 150,000 in passive loss carryforwards. You have no passive income yet, so those losses are sitting on your tax return waiting to be used. In year six, your first deal stabilizes and starts generating 8,000 per year in cash flow. That's passive income. You use your carryforwards to offset it completely tax free cash flow. In year seven, your second and third deals start generating cash flow too. Now you have 24,000 per year in passive income. Again, you use your carryforwards to offset it, still tax free. In year 10, your first deal sells, you invested 100,000 and you receive 200,000 back, a 100,000 capital gain. That gain is passive income. You use your remaining carryforwards to offset a large portion of it and significantly reducing your tax bill. Over 10 years. You've built a portfolio generating tax efficient cash flow and you've minimized taxes on your exits. That's the power of passive loss carryforwards. Now let's talk about depreciation recapture. Because this is something a lot of investors don't understand until it's too late. When you sell a syndication investment, the IRS requires you to recapture the depreciation you took over the years. Depreciation recapture is taxed as ordinary income up to a maximum rate of 25%. So if you took 100,000 in depreciation over the life of the investment, you'll owe up to 25,000 in depreciation recapture tax when you sell. But here's the good news. You can use your passive loss carryforwards to offset the recapture. If you have 100,000 in passive loss carryforwards, you can use them to offset the 100,000 in depreciation recapture, reducing or eliminating that tax. This is why tracking your carryforwards is so important. They're not just for offsetting cash flow, they're also a shield against depreciation recapture. Alright, let's talk strategy. How do you maximize the benefit of passive loss carryforwards? Invest consistently over time. Don't just do one deal and stop. Build a portfolio over five to 10 years. The more deals you invest in, the more passive losses you accumulate and the more tax flexibility you have in the future. Strategy 2 Prioritize deals with cost segregation. Not all syndications do cost segregation studies. Ask sponsors up front. Do you do cost seg? If they do, you'll get significantly larger passive losses in year one, which means bigger carry forwards for the future. Track your carry forwards religiously. Work with a real estate CPA who understands passive loss rules and tracks your carry forwards every year. This is non negotiable. Plan your exits strategically. When you sell an investment, you'll realize a capital gain. If you have passive loss carryforwards, you can use them to offset that gain. Talk to your CPA before you sell so you understand the tax implications and can plan accordingly. Consider real estate professional status. If you or your spouse can qualify as a real estate professional under IRS rules, you you can use passive losses to offset your active W2 income. This is a game changer, but it requires documentation and planning. We'll cover reps in a future episode. Alright, let's recap. Passive loss carryforwards are one of the most powerful tax strategies in real estate investing. Here's what you need to know. 1. Passive losses carry forward indefinitely until you have passive income to offset or you sell the investment. 2. The beautiful cycle is a four phase framework accumulation, cash flow, exit and reinvestment and financial independence. Use it to build and deploy passive loss carryforwards strategically over decades. 3. Track your carryforwards every single year. Work with a real estate CPA who understands passive loss rules. 4. Use your carryforwards to offset passive income and capital gains and depreciation recapture. 5. Invest consistently. Prioritize cost segregation and plan your exits strategically. Here's your action step. Schedule a meeting with your CPA and ask them, do I have passive loss carryforwards? How much, which properties are they from and how are you tracking them year over year? If your CPA can't answer those questions clearly, it's time to find a real estate CPA who can. And as always, consult with your CPA attorney and financial advisor before making any investment or tax decisions. If you're ready to start building a tax efficient passive income portfolio and you want help understanding how passive loss carryforwards fit into your long term strategy, let's talk. Check the show notes for a link to schedule a call with us@creipartners.com that wraps up episode 15. Thank you for joining me on this journey through the fundamentals of passive real estate investing. Over the past 15 episodes, we've covered everything from setting goals and building your team to evaluating deals and maximizing tax benefits. This is just the beginning. Keep learning, keep investing and keep building wealth with intention. Until next time. Remember, financial freedom isn't a dream, it's a decision. And it starts with understanding your tax strategy. I'm Crei Collin. Let's build wealth together.

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