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With inflation currently running over 8%, and voices on Capital Hill calling for tax increases, it’s more important than ever for High Net Worth investors and advisors to focus on triple-net returns.
This focus on triple-net means advisers and investors must place tax efficiency “front and center” when selecting new investments. Here are three tax-advantaged alts worth considering in 2022.
Click the play button above to listen to the conversation.
- Details on three specific types of tax-advantaged alts (plus a specific, real-world example of each product type).
- The best option for investors who are planning to realize a capital gain from the sale of real property.
- Another great option for investors who are planning to realize (or have already realized) a capital gain from an asset that is not real property.
Watch On YouTube
Featured On This Episode
- Origin Investments IncomePlus Fund
- Capital Square Open Offerings
- Urban Catalyst Qualified Opportunity Zone Fund II
About The Alternative Investment Podcast
The Alternative Investment Podcast covers new trends in the alternate investment landscape. Hosts Jimmy Atkinson and Andy Hagans discuss tax-advantaged investment strategies to help you grow your wealth.
Andy: Welcome to “The Alternative Investment Podcast.” I’m Andy Hagans.
Jimmy: And I’m Jimmy Atkinson.
Andy: And today we’re talking about tax-advantaged alts, and in particular, three types of alts that we think high net worth investors and their advisers should consider in 2022. And Jimmy, let’s talk about the backdrop a little bit first. Right? So, we had a lot of talk about possibly raising taxes earlier this year and in late last year. That didn’t end up happening, right?
But then, the other thing in the backdrop here is higher inflation, right? We have really high, you know, 8.5% CPI which is the highest it’s been in 40 years. And the PPI is even higher than that. So, we’re thinking it’s not going to be transitory as in going away in the next couple of months, right? And so, you know, to me, between all of the talk about increasing taxes and the higher inflation it’s like we have to focus on triple net returns, right?
High net worth investors and their advisors have to be focusing on triple net. You can’t just look at nominal returns.
Jimmy: Absolutely, Andy. And, you know, you mentioned high inflation and the 8.5% CPI print. I saw that housing is up even more than that. I think housing is up mid to high-teens. I saw one number that reported as high as 18 plus percent last year increase in housing costs, which is tremendous. So, let’s talk about some tax-advantaged products today, Andy. What’s the first type of tax-advantaged investment?
Andy: Yeah, good question. And so all three of these product types that we’re talking about today are real estate. They’re in the real estate asset class. And so, when you look at alts, of course, alts is a big broad space. It’s bigger than real estate, but real estate is probably the major, you know, asset class within the alternative space.
And, you know, we’re going to start broad and then we’re going to kind of get a little bit more specific as we walk through these three different options. And so, the first place to look, Jimmy, is just private equity real estate. That’s my first product type for today. And so what we’re talking about is a private offering, a fund for passive investors. And these are typically limited only to accredited investors.
And so, these are funds that, you know, they tend to own investment-grade assets, real estate assets. They can be in multifamily or other sectors. But they are managed by the sponsor to be very, very tax-efficient, right? And there’s different types of strategies that the sponsor can use to make these private equity funds tax efficient from the investor’s point of view.
So, just for an example of this type of product, I’m at origininvestments.com. And I’m on the Income Plus Fund page. So, if our listeners or viewers want to open that up, and we’ll also put a link to this in the show notes, this is just an example of this product type where the investor is looking for income as well as capital appreciation, but the sponsor has structured the fund and is operating the fund in a very tax-efficient way.
Right? So, it says right here under tax efficiency origin investments, as distributions are shielded by depreciation and other deductions, plus all capital appreciation is deferred throughout your time invested. So, Jimmy, even though this private equity fund, it’s not a DST, it’s not a QOF. Yeah.
It’s sort of a “normal” private equity… – It doesn’t have any particular type of wrapper. It’s simply… it’s probably just structured as an LLC partnership, if I had to guess.
Jimmy: That’s my guess as well. But nevertheless, and now I’ve scrolled down the page looking at the stat, 94% of 2021 distributions were sheltered from taxes as a tax-based return of capital, right? So, between the past through depreciation and other totally legal and ethical strategies like this, the fund is able to give investors that income stream as well as capital appreciation, but doing it in a very tax-efficient way.
So, I would encourage advisors and investors who are looking through all these private real estate offerings, and there are a ton of them, Jimmy. I mean, there are a ton. I like to look at a sponsor’s track record. I like to look for a sponsor, you know, it’s not their first rodeo, right? Who they’ve done ground-up development is usually, you know, very tax-efficient option.
And you can see that they’ve gone full cycle with previous products and that they sort of understand the best way to structure these to benefit their investors from that tax standpoint. So, I think this origin investment’s fund is a very good example of this type of private equity real estate fund where that tax efficiency is put front and center.
And again, if an investor is interested in a particular segment like multifamily or any other type of segment, you know, you can seek out sponsors that specialize in those different areas. Obviously, I love multifamily. I’m a multifamily guy. But that being said, Jimmy, we’ve started out with sort of this bigger, broader type of fund, but our next two options for our listeners, they’re going to be more specific.
So, what’s our second type of tax-advantaged alt that we’re going to discuss today? I’m going to tell you the second type and the third type. But I wanted to just touch one more point that you made in your last comment there, Andy. I would say not just sponsor, who the sponsor is, sponsor track record, but also, is the sponsor putting their money where their mouth is? And in the case of origin investments, the example you picked.
I know that the fund managers are two of the largest, if not the two largest investors in the fund too, which is very reassuring for a limited partner coming in, I can tell you. So, the next two types of tax-advantaged investments that Andy and I like today are number two is the Delaware Statutory Trust or DST wrapper, which can wrap around that private equity real estate fund that Andy just mentioned and add even more benefits on to it.
And number three, similar type of concept, it’s a wrapper, is the Qualified Opportunity Fund, which invests in Opportunity Zone properties. So, Andy, would you like me to go into number two here?
Andy: Yeah. And we do want to talk about the Delaware Statutory Trust. But one thing I want to mention to our listeners is, typically, all three of these products will be available only to accredited investors and they’re all good products, right? They’re all good segments. And it really just depends on the investor’s personal situation, I think, which product type will be the best fit for his or her particular situation.
Jimmy: Yeah, absolutely. So, I would actually say, let’s start there before we get to number two, which situation for each of these three different product types. Number one is a great product type for somebody who does not have a capital gain. If you don’t have a gain, you should really only look at number one because number two and number three all pertains specifically to investors who have a gain. Okay?
So, I’ll just preface it with that point right there. So, the number two product type is the Delaware Statutory Trust or the DST. And this is an excellent option for somebody who is already holding real estate property and who wants to do what is referred to as a section 1031 Exchange. I don’t know how much we’re going to get into details about section 1031 Exchange during today’s podcast episode.
We’ll probably touch that in more detail on a future episode or maybe we can point to something in our library on our show notes page for today’s episode, Andy. But essentially, a very high level, a 1031 Exchange is a light kind exchange whereby an investor divest himself or herself of one property and within a certain timeframe is able to defer gain on that first asset disposition by doing an exchange into another light kind property, so, real estate to real estate.
You have a gain from a real estate sale, and you invest in another real estate product within a certain timeframe. And there’s a few different timeframes you have to keep in mind that I won’t get into on this episode. And essentially, what that allows you to do is defer capital gain recognition indefinitely. And you can continue to perform these like kind exchanges throughout the course of your life and on death.
You have a fair market basis, I’m sorry, a basis step-up to fair market value for your heirs so they essentially never pay any capital gains on any of those real estate transactions that you conducted during the course of your lifetime.
Andy: Swap till you drop.
Jimmy: Exactly. Flop or swap till you drop. That’s right, Andy. So, that’s a really good type of tax-advantaged investment vehicle for a real estate property under section 1031 Exchange. That gets me to DST. The DST is essentially a fractionalized section 1031 Exchange. So, instead of owning the property directly, you would sell your property to begin the 1031 Exchange, and then you would invest in a much larger, sometimes institutional-quality fund that is structured as a Delaware Statutory Trust.
You still get all of the advantages of performing a section 1031 Exchange, you get that deferred gain indefinitely, but you don’t have to actually manage the property or hold the property directly. You get to pull your money in with a lot of other investors. So, sometimes these funds can be $10-$25 million, $50 plus million which are normally would be, you know, outside the range of most investors, but if you’ve got a gain of a $0.5 million or $1 million or $2 million bucks and you’re accredited, you can, you know, purchase a share or some shares of a DST fund and, you know, get access to that institutional quality product and fractionalized ownership of a much larger property.
Andy: So, example… – Plus, Jimmy, – and I have to… Let me interject.
Andy: All three of these alts that we’re talking about are for passive investors, right?
Jimmy: That’s correct.
Andy: So, a lot of times investors in a DST it’s an investor who’s in the past has actively owned a property, but would like to lock in that capital gain but defer it from the tax liability perspective and go passive when they like to kind of exchange it. So, the DST is the perfect vehicle to do that. And in many ways, it is similar to the third product type that we’re going to discuss here in a minute.
But again, I want to reiterate that the 1031 DST is only available to an investor who’s exiting that real estate asset, right? So, I can’t defer a capital gain from the sale of mutual funds or from the sale of a business or anything like that into a DST. So, the DST is a very attractive vehicle, but it’s limited in terms of who is even eligible to invest in it.
Jimmy: Yes, good point there, Andy. So, yeah. If you don’t have capital gains, you gotta go with number one. If you do have capital gains, you got to go… And they’re from real estate. You got to go with either number two or number three. If you have capital gains that aren’t from real estate, you’re going to want to take a look at the Qualified Opportunity Fund, which we’ll get to in a moment. But I wanted to bring up an example of a DST sponsor.
There’s dozens of DST sponsors in this country. One of the largest is Capitol Square. And they have… I’m just looking at their website right now. I’m diverting my eyes over here now to my main screen. And they’ve got a variety of DST products that are currently open. Typically, DST funds will only remain open for a few weeks at a time.
They open and close very quickly. There’s a limited offering on all of them. And the investors are highly motivated to get into them quickly because they want to be able to make sure that their investment is still eligible.
They only have a certain finite period of time to roll over their gain from their property sale into a DST fund. So, I won’t go through any specifics, but I’m just kind of going through and they’ve got… They have several multifamily DST funds. They also have an Amazon fulfillment center DST that you can get involved with all sorts of different property types when it comes to DSTs in terms of multifamily, different types of buildings.
They’ve got some high rises, some mid-rises, some condo-type places here. So, there’s no shortage of DST offerings out there, Andy.
Andy: Right. And these investors, again, they have very strict timetables where they need to be invested into the DST or at least have selected the DST after the sale of their real estate asset. So, timeline very much of the essence with those DST offerings. So, why don’t you tell us a little bit then about the third segment.
And I know, Jimmy, this third product type is near and dear to your heart. So, we’ll try and just give our listeners a brief overview, but, of course, in the show notes we will point them to all the resources they can handle and then some – if they want to learn more.
Jimmy: Yeah. Andy, I think that’s your polite way of telling me to keep it short and simple because I can be rather verbose on this topic sometimes because it is near and dear to my heart.
Andy: Well, you know, when you’re excited about a topic, it’s easy to be loquacious.
Jimmy: Yeah, very good. Very good point. So, this third type of tax-advantaged investment is really good, again, if you have a capital gain, but it doesn’t just have to be a real estate capital gain, it can be a real estate capital gain. But if you have gains from the stock market or sale of private business, or crypto assets, or any other types of collectibles, any type of gain, you can defer that gain through what is known as an opportunity zone investment.
And the vehicle that wraps around a private equity real estate fund is referred to as a Qualified Opportunity Fund. So, this is a… It’s mostly used for real estate investments. It can be multifamily, or office, or hospitality. Lots of different types of private equity real estate funds that take advantage of this product wrapper, But the real estate has to be located in specially designated opportunity zone census tracts which are, for the most part, low-income census tracts located all over the country.
And the investor gets some incredible tax benefits, one of which is a deferral period on an initial capital gains. So, again, it’s a capital gain tax program. You have to start with a capital gain. You get to defer your capital gain until the end of 2026. And then, if you hold your opportunity zone investment for at least 10 years, the opportunity zone investment itself, all the appreciation there comes out tax-free profits after 10 years, which is really why the program has attracted as much attention as it has.
So, one example of a Qualified Opportunity Fund that I’ll point out today is the Urban Catalyst Qualified Opportunity Zone Fund 2. It’s their second fund offering. Fund 1 they closed a couple of years ago. They are a real estate developer in downtown San Jose. And much of downtown San Jose, despite being located in close proximity to Silicon Valley, in fact, it’s in Silicon Valley, but close proximity to a lot of the companies that are headquartered in Silicon Valley just a little bit up the road to the north, a large part of downtown is located in an opportunity zone.
And we do see migration of some of those tech companies down the bay south to San Jose, Google is building a huge campus there. Zoom and Adobe are already there. But the fact of the matter is the downtown area is a little bit economically downtrodden and low-income as it was designated as a opportunity zone.
So, I’ll tell you a little bit more about Urban Catalyst Opportunity Zone Fund 2. It’s a two-asset fund, two-project fund. The two projects are actually located on adjacent plots of land on one city block. One of them is a high-rise apartment building with 300-plus units. I should correct myself there.
It’s actually mid-rise. There’s no high rises in downtown San Jose because the airport is too close. And then the second building is office building right next door that has over 400,000 square feet. They’ve just acquired, I believe, all of the land there and they’re going to start construction on it, I think, either later this year or next year. So, that’s a recap of qualified opportunity zone investing, Andy, and an example of a fund that – is open today.
Andy: Yeah. And Jimmy, we should mention that we have had all three of these real estate sponsors, all three of these fund sponsors on some of our events in the past. And all three of them, in my experience, have been very professional, given great presentations, had great reactions from our investors. So, I do want to disclose that we have that, you know, relationship with these companies.
But we have… There are many, many options for all of these product types whether you’re talking private equity real estate fund or Delaware Statutory Trust, DST, or Qualified Opportunity Funds. So, as always, you know, we’d advise self-directed investors or advisors to do plenty of research and do plenty of diligence because there’s plenty of good offerings out there, very high-quality offerings that I think could really reward investors who need tax efficiency, who need tax-efficient investments in the current landscape that we’re in.
Jimmy: Absolutely, Andy. Well, Andy, I think we’ll wrap it up there. It’s been a pleasure today for our listeners. If you want links to all of the resources we discussed on today’s episode, you can access the show notes at altsdb.com/podcast.