Tax Benefits of Investing in Trust Deeds

Investing in trust deeds through debt funds has become an increasingly popular strategy for investors seeking stable returns and reduced volatility. One of the significant advantages of this investment approach is the tax benefits it offers. Let’s explore the various tax benefits of investing in trust deeds via debt funds, and get an insightful and detailed overview for potential investors.

What Are Trust Deeds?

A trust deed investment involves lending money to a borrower, secured by real estate. In essence, the investor acts as the lender, and the property serves as collateral for the loan. This type of investment is typically arranged through a debt fund, which pools capital from multiple investors to fund these real estate-backed loans. The borrower makes regular interest payments to the debt fund, which then distributes the income to its investors.

Overview of Debt Funds

Debt funds are investment vehicles that primarily invest in fixed-income securities, such as bonds, mortgage-backed securities, and trust deeds. These funds are managed by professional fund managers who carefully select and manage the portfolio of loans. Investing in a debt fund offers several advantages, including diversification, professional management, and access to higher-quality investment opportunities.

Tax Benefits of Investing in Trust Deeds via Debt Funds

1. Interest Income

One of the primary tax benefits of investing in trust deeds is the treatment of interest income. Interest payments received from trust deed investments are typically considered ordinary income. However, the advantage lies in the fact that these interest payments can be offset by deductions for related expenses, such as loan servicing fees, fund management fees, and other administrative costs. This can significantly reduce the taxable portion of your income, effectively lowering your overall tax liability.

2. Depreciation Deductions

While the direct ownership of real estate allows investors to take advantage of depreciation deductions, investing through a debt fund provides an indirect benefit. The properties backing the loans in a trust deed investment can depreciate over time. Although investors in a debt fund do not directly own the properties, the fund itself can claim depreciation expenses. These expenses can reduce the overall taxable income of the fund, thereby increasing the net returns distributed to investors.

3. Tax-Deferred Growth

Investing in a debt fund that holds trust deeds can offer tax-deferred growth, particularly when the fund is structured as a Real Estate Investment Trust (REIT) or a similar entity. In this case, the income generated by the trust deeds is not taxed at the fund level. Instead, investors pay taxes on the distributions they receive. This allows the investment to grow tax-deferred within the fund, potentially increasing the compounding effect and overall returns.

4. Capital Gains Treatment

When a trust deed investment is held within a debt fund, the eventual sale of the underlying property can result in capital gains. Long-term capital gains, which apply to assets held for more than a year, are typically taxed at a lower rate than ordinary income. This favorable tax treatment can enhance the after-tax returns for investors.

5. Pass-Through Deduction (Section 199A)

Under the Tax Cuts and Jobs Act of 2017, certain income from pass-through entities, such as REITs and other qualified business entities, may be eligible for a 20% deduction under Section 199A. If the debt fund qualifies as a pass-through entity, investors might be able to deduct up to 20% of their qualified business income (QBI) from their taxable income, further reducing their tax liability. This deduction can apply to the income generated from trust deed investments within the fund.

6. Estate Planning Benefits

Trust deed investments via debt funds can also offer estate planning benefits. By placing these investments within a trust or other estate planning vehicle, investors can potentially reduce estate taxes and ensure a smooth transfer of assets to their heirs. Additionally, the steady income from trust deeds can provide financial support to beneficiaries, enhancing the overall value of the estate.

Practical Example

Let’s consider a practical example to illustrate the tax benefits of investing in trust deeds via a debt fund. Suppose an investor places $250,000 in a debt fund that offers an annual return of 8%. Over the course of a year, the investor would receive $20,000 in interest income.

Expense Deductions

Assuming the fund incurs management fees and other related expenses totaling $5,000, the investor can deduct these expenses from their interest income, reducing the taxable portion to $15,000. If the investor is in the 32% tax bracket, the tax liability on this income would be $4,800, rather than $6,400 without the deductions.

Depreciation and Capital Gains

If the properties backing the loans depreciate, the fund can claim these expenses, reducing its overall taxable income. Additionally, if the fund sells a property after holding it for more than a year, any gains realized from the sale would be taxed at the long-term capital gains rate, which is typically lower than the ordinary income tax rate.

Pass-Through Deduction

If the fund qualifies as a pass-through entity, the investor might be able to deduct 20% of their qualified business income. In this case, the investor could potentially reduce their taxable income by an additional $3,000 ($15,000 x 20%), further lowering their tax liability.

Investing in trust deeds via debt funds offers a range of tax benefits that can enhance the overall returns and financial stability of your investment portfolio. From interest income deductions and depreciation benefits to favorable capital gains treatment and potential pass-through deductions, these advantages make trust deed investments an attractive option for savvy investors.

At LBC Capital Income Fund, LLC, we specialize in managing debt funds that invest in high-quality trust deeds, providing our clients with secure and profitable investment opportunities. By leveraging our expertise and understanding of the tax landscape, we help our investors maximize their returns while minimizing their tax liabilities.

Ready to explore the tax benefits of investing in trust deeds through LBC Capital Income Fund, LLC’s debt fund? Contact us today to learn more about our investment opportunities and how we can help you achieve your financial goals.