Depending on your financial goals and desired tax benefits, FIC offers two types of investments: Leveraged and Unleveraged. Not sure which Fund is right for you?
In this article, Eric Shelly has compared the features of our Leveraged and Unleveraged Funds so that you can determine with your financial advisors which one is best for your needs.
To my fellow investors:
Freedom Impact Consulting provides several syndicated investments in Clean Energy, Real Estate, and other real asset classes with our most popular being Carbon Capture Technology.
These are our flagship funds here at FIC. Using an innovative tax-saving strategy, investors are able to claim depreciation that equals 2X their investment amount. That has been one of the most attractive features in the investment and has created a huge demand.
We have enjoyed the benefits of 100% bonus depreciation, since the Tax Cuts and Jobs Act was enacted at the end of 2018. However, beginning in 2023 — bonus depreciation will be reduced to 80%.
It was scheduled to sunset in 2023, reducing 20% each year until it hits 0% in five years. We hope that the Congress will see that this was beneficial in spurring on economic activity and they will consider bringing it back.
Therefore, I want to address some concerns that you might have regarding our Carbon Capture.
Leveraged and Unleveraged Funds
Leveraged Funds
In this type of fund, we raise 50% of thecapital from investors and 50% is borrowed in the form of a loan from our operator, CETA.
Our Leveraged Fund offering allows investors to take a Bonus Depreciation of 2X the investment amount. For example, $100K investment allows for $200k Bonus Depreciation.
This is the $100,000 investment and the $100,000 loan for each share: a total of $200,000 eligible for depreciation. A large portion of these losses is created by depreciation that’s claimed in the first year.
You will notice there are two schedules for depreciation over six years. We will be using the half year convention for all funds in the first 3 quarters of 2023. For the 4th quarter funds we will be using the mid-quarter convention.
You will notice in this table that the depreciation for Year One includes the 80% bonus depreciation of $160,000 plus the 20% of the scheduled depreciation ($8,000) of the balance, totaling $168,000.
Why Our Investors Join As A General Partner
Our investors join as a General Partner (GP) so that they can take on the risk of any losses inside that partnership — risk is necessary to get tax benefits. Each of the investors must guarantee their portion of the loan.
This allows them to claim the pass-through depreciation and bonus depreciation from any assets acquired. You must sign a note for your portion of the note on the equipment, in order to establish your basis for the Bonus Depreciation deduction that you are taking.
Oil & gas investments are considered as active income for all investors. If you own a working interest in any oil or gas property, either directly or through an entity that doesn’t limit your liability concerning the interest, it is not a passive activity, regardless of your participation. (Section 1.469-1T.)
A working interest is a type of investment in which the investor is directly liable for a portion of the ongoing costs associated with exploration, drilling, and production, like that of a General Partner.
To take losses against your ordinary income, you must demonstrate active participation in the activity you are claiming these losses from. So even if you are not materially participating, your working interest as a GP affords you the benefit of claiming such losses against your W-2 income.
Technically, you can invest as an LLC but you will not be able to enjoy the full tax benefits. As mentioned, GP liability is necessary to get the beneficial income tax treatment of depreciation expenses. But it is still likely to be considered active income, as it is for everyone else.
We suggest you consult your tax advisors on this matter.
Additional Liabilities
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, the amount of loan repayment is taxed each year despite the fact that you don’t receive that income as a payment.
On the Leveraged Funds, we are borrowing 50% of the cost of the equipment and we pay back the loan in 1-3 years from the deal revenue. 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. We have created an investing strategy that allows us to convert this active income into passive income.
Unleveraged Funds
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.
Below you will find a table that shows the way we will be taking the depreciation for our next leveraged fund, Oshares 05. This schedule looks the same as the schedule above but the minimum share in this fund is 200,000 with no loan.
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 12-15 years. This means that over the life of the deal, investors in the unleveraged deal have the opportunity to earn more revenue.
How do these deals compare?
Tax Liability
The Leveraged deal front loads the depreciation and then pays additional taxes on principle payments until the taxes paid are equal to the unleveraged 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.
The “phantom” income created by the repayment of the loan is also an active income that is taxed at the active tax rate. So you can see that there are several opportunities to use the remaining depreciation to offset income taxed at the active income rate.
As for the reduction in Bonus Depreciation rates, our deals are not greatly affected by this change. You will not notice the reduction of bonus depreciation as much in the first year as you will in subsequent years, but this change will only spread out the depreciation. It will not eliminate it.
Offsetting Ordinary Income
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 Unleveraged.
You may be concerned that we are no longer able to maximize the amount of W2 income we can offset because we must be a general partner to get this benefit. We are then converting to a limited partnership after the first year with 18% of the depreciation remaining.
However, the income from this deal remains active throughout the deal. Any depreciation offsetting this active income in subsequent years will be equivalent to a deduction against W2 income.
Conclusion
We have compared the features of our leveraged and unleveraged funds so that you can determine with your advisors which one is best for you.
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. 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.
In the unleveraged 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. The unleveraged funds offer a greater upside but with exposure to the volatility of production.
For either of the Funds, growing tax liability from these active income returns is a concern. If you compare tax liability between leveraged and unleveraged deals, they are equal by the time the loan is paid off.
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 have created investment strategies, such as Real Estate, to convert this active income into passive income. This framework will help decrease the growing “snowball” of tax liability by accumulating long term depreciation.
Revised February 2023