Maximizing Tax Benefits Through Multifamily Investing

Multifamily investing offers robust returns without the volatility of the stock market.

Yet, when you add in the tax benefits, you can optimize financial strategies to achieve even higher rates of return not reflected in IRR (Internal rate of return) and cash-on-cash calculations.

Here are a few of the tax advantages you may benefit from when investing in multifamily:

Operating Expense Deductions: All businesses deduct expenses from revenue to establish net operating income.

Multifamily investments generally operate as a partnership, LLC, or corporation, giving the business access to operating cost deductions. Expenses generally include property management fees, utilities, insurance, taxes, marketing, maintenance, and employee expenses.

Capital Expenses include one-time costs for major repairs or renovations. Examples might include replacing systems such as the HVAC, roof replacement, painting, or unit upgrades. It might also include adding amenities such as a pool or gym.

The IRS has an established depreciation schedule for capital expenses that provides deductions over the life of the improvement.

However, most projects qualify for accelerated deprecation using the 179 deduction, which allows you to deduct the cost in the year the business incurs the expense.

General Depreciation allows you to recover the cost of the property over time by deducting a portion of the asset’s value each year. In most cases, real estate depreciates over 27.5 years (minus the land cost), reducing the tax liability each year of ownership without impacting cash on hand.

Bonus depreciation allows you to accelerate depreciation through cost segregation, which is significant because most investors do not hold assets for the entire 27.5 years.

Purchases not qualifying for the 179 deductions may be eligible for bonus depreciation through 2026 when bonus depreciation expires. In 2024, you could be eligible for 60% bonus depreciation on real estate purchases.

The Passive Income Benefit: Rental income from a multifamily investment is considered passive income. This designation allows you to offset losses from other passive investments, potentially reducing your tax liability.

1031 Exchanges allow you to defer taxes as long as you re-invest in another qualified investment. Utilizing a 1031 exchange preserves wealth because you can re-invest all the gains and defer taxes indefinitely.

Qualifying for Tax Credits could further reduce your tax liability. The two main tax credits applying to multifamily housing are the home energy tax credit and the low-income housing tax credit.

Adding energy-efficient features like solar panels, energy-efficient HVAC systems, or water heaters may qualify for tax credits.

Renovating multifamily complexes into affordable housing units may qualify for a tax credit. To qualify, at least 20% of the units must house tenants with an income of 50% or less of the median income in the area based on family size.

Tax-advantaged Accounts: Using funds from a solo 401k or self-directed IRA provides additional tax benefits. Contributions to these accounts grow tax-deferred or tax-free, depending on the account. Using these accounts to fund real estate projects can result in substantial long-term savings and enhanced financial flexibility.

Multifamily investing offers a unique blend of income potential and tax savings. By strategically navigating deductible expenses, utilizing depreciation to reduce tax liability, exploring tax credits, and leveraging tax-advantaged accounts, you can optimize your tax position and build a more resilient and profitable real estate portfolio.

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