Tax Benefits Of Investing In Multi-Family Real Estate

Taxes are a very large part of the costs incurred by rental property investors. Since you are obligated to pay taxes, there is no way to avoid payment without breaking the law. Having said that, there are also several tax benefits associated with a multi-family real estate. Multi-family homeowners who actively manage their potential tax liability are more likely to generate higher returns than those who do not. Let’s understand these tax benefits.

Tax Benefits Of Multi-Family Real Estate Investing

Like any other type of investment property, there are substantial tax breaks for multi-family real estate investments. Knowing about these can help you save thousands of dollars in taxes each year.

Depreciation Tax

One of the best tax benefits of real estate investing, depreciation allows investors to reduce their taxable income. In some cases, losses equal to or greater than the free cash flow expected to be received by the investor can be written off and reported. This means, sometimes, that taxable income can be $0 in some cases. Depreciation can be applied in 2 ways:

Straight-line depreciation:

A common method of depreciation, straight-line depreciation is where an investment property’s cost is depreciated the same amount for every accounting period. Note that you can only depreciate the value of the building, not the land. This is because, according to the IRS, while land lasts forever, a building is assumed to have a lifespan of 27.5 years.

Accelerated depreciation:

Accelerated depreciation is a depreciation method that allows the recognition of higher depreciation expenses in previous years. The most important and common accelerated depreciation methods include the Double-Declining balance and the Sum of the Years’ Digits.

Cost Segregation

Multi-family investment properties can also take advantage of cost segregation. Similar to depreciation, cost segregation takes into account the values of the objects inside the property as well. A cost segregation analysis is a survey conducted by a surveyor or engineer who performs a basic inspection of physical assets and attempts to divide them into four categories: personal property, property improvements, buildings/structures, and land. Due to this segmentation, the depreciation can be accelerated by taking it over a shorter duration. For example, the IRS considers items such as cabinetry, fixtures, and appliances to have a shorter lifespan. That’s why they allow real estate investors to make depreciation expense write-offs on these items for a period of 7 years.

Although exact calculations can be complicated and should be left to qualified professionals, it is important to know that performing an expense segregation analysis and accelerating the allowable depreciation of related assets can lead to significant tax savings.

Tax Deductions Related To Real Estate

Legally, you are allowed to deduct from your total taxable rental income the expenses you incur to maintain, manage, and repair your multi-family real estate. The following deductions can help you save a lot of tax:

• Mortgage interest
• Insurance premiums
• Maintenance and repair expenses
• Marketing costs
• Management costs
• Utilities

Writing off these deductions can help you rake in tax benefits of real estate investing.

Passive Income Tax

Passive income includes income earned through rental property, limited partnerships, or other businesses in which the individual does not have an active participation. The tax for this is calculated at passive income rate and is generally lower than regular income tax rates. An important point to be noted is that this applies only to investors who actually use real estate as a passive source of income, not to real estate professionals.

1031 Exchange Tax Benefits

Section 1031 of the Internal Revenue Code lets a multi-family real estate owner defer capital gains taxes on a profitable sale by reinvesting the profits into another property of “like kind. And although there is no limit to the number of times it can be done, there are a few criteria to be met:

• The new property must be equal or greater in value than the old one
• The new property must be of the same nature or character as the old one
• The new property must be found within 45 days of the close of the sale of the old one, and its purchase must be completed within 180 days of the sale.

Let Experts Manage Your Property

Proactively managing an investment’s tax liability is a great way to allow profits to grow. Maximizing depreciation through cost segregation and deferring capital gains taxes through 1031 exchanges can definitely help you expand your returns on investments.

We at BFPM expertly manage your multi-family investment properties. From tenant screening and property management and maintenance, to streamlining bookkeeping and vacancy marketing and advertising, we do it all efficiently and effectively. To know more about our services, feel free to set up a quick 15-minute consultation call with us. We’d be happy to tell you about our expertise.