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Amplify Your Earnings: 5 Tax Advantages of Multifamily Investing

Multifamily is a great way to invest in a physical asset and enjoy the quick cash flow and equity that come along with it. So, wouldn’t it be great to find a way to maximize these earnings and keep more cash in your own hands? 

There are tax benefits with multifamily investing that will help you achieve that. This article talks about five tax advantages of multifamily investing and how to use these benefits to amplify your earnings. Depreciation, cost segregation, 1031 exchange, passive income tax, and gifting and estate tax breaks may help you save over time and keep more money securely in your pocket. 

Consider these tax benefits when investing in multifamily and see what savings will best help your bottom line.

Depreciation

Depreciation is a reasonable allowance for the wear and tear of a property. 

Multifamily properties include systems such as heating and cooling, plumbing, electrical, and security (locking mechanisms and alarms). As these systems are used and exposed to the elements over time, they start to show wear and tear as a natural consequence. Because of this, property owners may write off a portion of the property’s value as an “expense” to account for the expected level of deterioration. 

Depreciation lowers the property owner’s tax liability by reducing the net operating income. The IRS considers the useful life of a multifamily property to be 27.5 years. You can break down the annual depreciation amount by dividing the property’s value by 27.5.

Therefore, a multifamily property purchased for $500,000 would have an annual depreciation expense of $18,182. You could deduct this from your net operating income and lower your tax liability.

Cost Segregation

A cost segregation study itemizes expenses into four categories.

  • Personal property
  • Land improvements
  • Buildings and structures
  • Land

Because each area of a multifamily property is used at a different rate and level of intensity, items will depreciate at varying rates. A cost segregation study allows you to separate items that depreciate faster to initially bring your taxable income down. 

For comparison, personal property depreciates at a rate of five to seven years, while land improvements (parking lots, sidewalks, playgrounds) depreciate at a rate of 15 years. With the variation in depreciation rates and the complexity of the math involved, an experienced professional should perform cost segregation studies. This will ensure accuracy and compliance.

1031 Exchange

If you plan on reinvesting earnings from one multifamily property into another, a 1031 exchange is the way to go. Doing so will allow you to defer taxes ranging between 15%-28% on your capital gains. 

Section 1031 of the Internal Revenue Code states that real estate investors may defer capital gains taxes when the earnings are invested in another property. The guidelines that an exchange must meet include the following:

  • The newly purchased property is of equal or greater value than the sold property.
  • Both properties are the same in nature or titled similarly (apartment complexes, condominiums, etc.).
  • The money invested in the newly purchased property equals the earnings on the sold property.
  • The purchased property is identified within 45 days of closing, and the purchase transaction is completed within 180 days.

Passive Income Tax

This tax benefit is for investors who do not qualify as a “real estate professional” because the tax rate for passive income is less than the rate for federal income tax.

A “real estate professional” is anyone who spends at least 500 hours on their real estate ventures annually. The typical passive investor doesn’t spend such a significant amount of time on their investments and will only be required to pay passive income tax and capital gains tax (if they choose not to reinvest their earnings). 

Gifting and Estate Tax

If you would like to pass down your stake in a multifamily real estate syndication, you can reduce the value of a gifted investment by as much as 30%. This is because you have limited control over the LLC’s earned interest as a passive investor. Doing so will reduce the tax liability for the person who receives the gift.

Investing in multifamily real estate is an exciting way to grow your personal wealth and gain financial freedom. Utilizing these tax benefits will help you amplify your earnings and protect your bottom line. 

Want to learn more about how to increase your wealth and build a legacy for your family?

Contact the team at Height Capital to discuss our exciting opportunities.