Return "On" vs "Of" Capital - Understanding the Impact on Apartment Investing

Return "of" capital – your money is being returned, so it's a non taxable event.

Return "on" capital – this is considered a profit, so this would be subject to tax.

Oftentimes, sponsors will structure the deals cash flow to be considered return "of" capital.

It's not taxed, but the only downside is when there's a preferred return of the cash flow, say 8%, this 8% is on less principal as your capital is being returned.

For example, your $100,000 investment with an 8% preferred return would be $8,000. By the next year, you now are getting 8% on $92,000 ($7,360).

Even though your initial principal is reduced, you still maintain the same equity percentage of the deal.

Overall, it's not a huge issue either way because with the bonus depreciation at the time of writing this, you are really paying taxes on the cash flow anyway.

Note:

Deals can be structured in nearly any way. I have seen people do a preferred return structure with a return "of" capital where the preferred return amount is still based on the initial investment, not the remaining capital in the deal.

Amazon link