Since we began our Carbon Capture investments back in 2019, we’ve found that the tax planning benefits of these funds are most effective in reducing tax liability in the first year.
The leveraged funds allow for 2x bonus depreciation in Year 1 taking it to the next level. As time goes on, we are starting to understand how taxes are affected in subsequent years.
For the 50% leveraged funds, the investor ends up paying tax on the $40,000 per share revenue plus the $33,000 principal paydown of the 50% loan in the second year.
That loan is paid by the fund, but this is still considered as income to the investor and is passed on through the K-1. That is a total taxable income of $73,000 for Years 1-3 and then $40,000 for Years 4-7.
The point is that once we take the bonus depreciation there are no more deductions left for that fund and the income is fully taxable.
The Tax Problem
To cover the tax liability for the fund income for the next year, many of you are investing every year. The upside is that you are creating great cash flow streams.
The problem is you are rolling up a giant snowball in tax liability.
Real Estate Investing
We need a way to use some of the proceeds and other investment capital to invest in Real Estate. The strategy needs to address several issues:
- We need to have depreciation.
- We need to extend cashflow beyond 7 years since the leveraged deal ends at that time.
- We need to avoid taxable events like an asset sale.
- We need to have cashflow to support the strategy.
- We need to convert active income to passive income.
If we can identify a real estate asset that can address these issues, we can solve some of the tax issues created by the CO2 funds. Many deals we see today in multifamily and self-storage are structured for value add and sale in 3-5 years.
This doesn’t make sense for our situation because it will just create a taxable event. We would have the option of a 1031 but that would only make sense if we had a large gain, and we could upgrade the asset.
Infinite Return Model
A better strategy would be the infinite return model. In this model, we would buy the property at a good price and add value through improvements, rent increases, and possible zoning changes.
We would do a cost segregation to give us 60-80% bonus depreciation in Year 1. This would create a cashflow that would support the deal but allow for maximum equity growth.
Finally, we would do a cash out refinance every 3-5 years and return most or all of the initial investor capital, tax-free. The investor could then reinvest this in another real estate asset and repeat the process with the same capital.
I want to emphasize that unlike selling the property, a cash out refinance can take advantage of value add, appreciation, and equity paydown without creating capital gains.
Think of this like a tax-free ATM.
Converting Active Income to Passive Income
Investing in Real Estate assets creates passive income. The CO2 funds have an active income which is taxed at an ordinary tax rate.
By using the income from CO2 funds to invest in Real Estate assets, we are effectively converting from active income assets to passive income assets and reducing the tax rate.
Other advantages of this model would include a modest cash flow of 6% preferred cashflow. We would also get 27-40 years straight line depreciation for each asset we invest in.
We would get tax deductions for property expenses and interest on the mortgage which would likely offset most or all the cashflow income.
Another advantage that I’d like to mention is that the value of each asset should continue to appreciate over time. Each time we build up enough equity to justify a cash out refinance we will continue to harvest our equity to reinvest in more assets.
By investing in both CO2 funds and infinite return real estate, we can take some control of the ever-growing snowball of CO2 fund taxes and use the real estate depreciation to reduce the size of that snowball.
We can convert our active income to passive income and shrink the impact of taxes. We can also extend the cashflow on the leveraged CO2 funds beyond 7 years.
I am working with an expert to figure out some optimum ratios for this combination of investing. We have identified some potential properties that are currently available.
If we can close a deal, I am going to personally invest and may have opportunities for you to invest alongside me. Please stay tuned for information on future investment opportunities.
We will be announcing a webinar shortly to discuss this concept and assess your appetite for this type of investment. We would appreciate your feedback!
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Prior to making any decision to contribute capital, all investors must review and execute all private offering documents, including the Private Placement Memorandum and its exhibits, which contains the complete information about this investment opportunity.
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