I want to address the issues associated with our leveraged and unleveraged funds. As you may know, the use of leverage in our Shares Fund offering allows for taking a bonus depreciation of 2X the investment amount.
For example, 100k investment allows 200k bonus depreciation.
That has been one of the most attractive features in the investment and has created a huge demand. I want to expand on the features of this deal and compare it to the non-leveraged deals as well.
We will start with the leveraged fund. In this type of fund, we raise 50% of the capital from investors and 50% is borrowed in the form of a loan from our operator, CETA.
We are allowed to take bonus depreciation for the full purchase price of the equipment which is 2X the investment. Each of the investors must guarantee their portion of the loan.
Many investors have concerns with the additional liability. However, since CETA is both lender and operator they are in a position as manager to ensure that we are being paid by the oil companies leasing our equipment.
If CETA operates properly, the revenue to pay back the loan to them will be there. The other ramification of the leverage is that the revenue we use to pay back the loan is taxable.
That means that in addition to the returns, we will also pay tax on principle repayment. Principle repayment is a phantom income that doesn’t come directly to us.
In our Shares Fund, the return is 40K and the loan has a 3-year term paying 33.33K in principal for a total of 73.33K taxable for 3 years.
This up-front tax savings is a powerful tool for our accounts to use to reduce our tax liability. You just need to be aware that you are pushing taxes down the road as they accumulate.
You will need a further strategy to address this growing “snowball” of taxes. Many of our investors are investing every year to continue pushing these taxes down the road.
Let’s move on to the non-leveraged fund.
In this fund, we raise 100% of the capital from our investors. The bonus depreciation in year one is the full cost of the equipment. In this fund, it is the same, or 1X the original investment.
With no loans to pay there is no phantom income, so we only pay tax on the returns.
We decided to structure this fund with some additional benefits to make up for the less attractive tax benefits.
The investors will own their share of the equipment. The returns will be variable based on their share of the deal revenue.
As a result, there will be earnings up to the estimated life of the equipment, which is rated at 15 years. This means that over the life of the deal, investors in the non-leveraged deal have the opportunity to earn more revenue.
How do these deals compare?
If you compare tax liability between leveraged and non-leveraged deals, they are equal by the time the loan is paid off.
The leveraged deal front loads the depreciation and then pays additional taxes on principle payments until the taxes paid are equal to the non-leveraged deal in year 1.
This allows for tax planning to maximize tax savings. Your accountant can help you determine which is best for your situation.
In our experience, our investors with high W2 or ordinary income can reduce taxes with minimum investment using leverage.
Investors who don’t need to offset high W2 incomes can still get tax reduction and higher cash accumulation with non-leveraged.
Another advantage of the leveraged fund is that we provide a preferred fixed payout where the investor is protected from volatility, making it easy to understand the payout.
The non-leveraged funds offer a greater upside but with exposure to the volatility of production.
Equity vs Debt
In the leveraged fund the investors are not equity participants. It is a debt fund.
At the end of seven years, they exit the investment.
In the non-leveraged fund, investors will be part of the deal for the life of the equipment and will receive their share of the revenue as long as the equipment is functioning.
We have compared the features of our leveraged and non-leveraged funds so that you can determine with your advisors which one is best for you.
One of the most important insights we have gained in this analysis is that the tax liability accumulates after we tax the upfront bonus depreciation.
If we invest yearly — as do many of our investors — the tax liabilities will continue to grow.
We are currently looking at some investment strategies that will help decrease the growing “snowball” of tax liability by accumulating long term depreciation.