Tax season is fast approaching. Due to the rules, complexities, and money involved, many multifamily investors may feel overwhelmed. The good news is that there are tax strategies that real estate investors can take advantage of, and there are several tax benefits of owning a multifamily home. While we can’t share explicit tax advice, and it’s always a good idea to speak with a real estate attorney or home finance professional, in this post, we’ll share our 5 tax tips for multifamily investors so that you can learn some of the various benefits, options, and laws in place that allow you to save money. Disclaimer: The information provided in this blog does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this blog are for general informational purposes only.
Depreciation
While your property is in service (which starts as soon as your property is ready to be rented out), it may qualify for depreciation. Over time, your property experiences wear and tear, thus losing value. But, over time, you put money back into the home, first by buying the property and then through repairs as it ages. Depreciation allows you to deduct the taxes on the amount that you’ve put back into your property as it wears down. Then, you can subtract that number from your rental income earnings. This process takes place over a set amount of years and is calculated by dividing the cost of the building by the number of years you can legally claim that it will depreciate. For residential properties, the years that the property is counted as useful is set at 27.5. For commercial properties, the number is 39. Each year, you can divide the cost of the property by the number of years it will depreciate over and subtract that amount from your rental income. Say you paid $200,000 for the building alone (land cannot be depreciated, so the cost of the land is excluded). If it was a residential property, for the first year, you could calculate it like this: 200,000 / 27.5 = 7,272.73 This number is added to the expenses portion on the 1040 form of your Section E, and is subtracted from your total rental income. Figuring out how to correctly calculate depreciation can be tricky, as you can only depreciate the property itself, not the land it was built on, so you must separate those costs. However, this can offer relief on your tax bill and keep money in your pocket each year. Keep in mind, if you use this strategy and then go to sell the property later, you’ll owe a depreciation recapture tax.
Cost Segregation
Cost Segregation is a strategy that uses depreciation. Normally, depreciation happens over a 39-year period for commercial properties or a 27.5-year period for residential properties. However, by using Cost Segregation, you can split up your property further, sorting it into different classes. Since different classes can have even shorter depreciation periods (5,7, or 15 years) any part of the property that falls under those classes can have deductions made at a steeper rate. You may need to have a team analyze your building in order to determine what falls where. The price to hire them can, on average, cost between $5,000-$15,000, but depending on the type of multifamily property you own and its price tag, the gains might well outweigh the cost. For multifamily properties, this strategy can be valuable, especially for apartment building owners whose property came at a higher price tag.
Businesses Get Business Deductions
As an investor, you may technically be a business, which means you could get business tax deductions! These can include things like:
- Mileage. This includes gas going to and from your property, and also travel expenses.
- Office space. You may be able to write off an office, or even a part of your home.
- Property Manager
- Lawyer
- Accountant
- Repair and maintenance costs
- Utility bills
- Insurance premiums
- Section 179 deductions
A good tip is to save all of the receipts for anything you buy that relates to your property. If you have to buy a new appliance, hire an accountant to keep the books relating to your property, or take on a property manager to care for your residents, you’ll want to keep a detailed record of the purchases to see if they can be written off at the end of the year.
1031 Exchange
While there are many rules to follow under the 1031 Exchange of the Internal Revenue Code (IRC), it may allow you to defer all of your capital gains when acquiring a new property. Essentially, a property investor can sell their property and then, within a set number of days, invest the profits of the sale into a like-kind classified property. The investor can hold off on paying the tax on the capital gains of the sale, which they would normally have to pay, and instead invest those funds into a newly-acquired property. Personal properties do not qualify so, as a multifamily investor, it may be easier to take advantage of this exchange rule since both the sold and acquired property must be used for investment purposes. If you’re looking to build up your portfolio and upgrade properties, this is a tax law to be aware of. If you’ve deprecated your property, this could potentially save you from having to pay a depreciation recapture tax. Of course, there are many rules to follow and the sale and purchase have to be completed on a set timeline as well. Luckily, we have an entire article dedicated to the 1031 exchange that you can view here>>.
Tax Benefits for Properties Owned for Over a Year
Capital Gains
This tip only applies to investors who have sold a property within the last year or are planning to sell a property. Capital gains are the amount you make after selling an asset. For example, if you bought a property for $300,000 and sold it for $400,000, then your capital gains are $100,000. However, if you buy a property and sell it before you’ve held it for a year, you may be subject to a 10-37% tax on whatever gains you make, depending on your filing status and total gains. So, if you’re a single filer and you fall into the 32% tax bracket, you’ve got to fork over $32,000. However, after holding property for over 365 days, if you decide to sell, then the tax brackets on those capital gains is 0-20% versus 10-37%. In our make-believe scenario, instead of $32,000, you’d pay only $15,000. That’s $17,000 back into your pocket. Especially for multifamily investors whose properties may be worth larger sums of money, this tax rule is one to keep in mind. If you’d like to learn more about both short-term and long-term capital gains, then we recommend you check out this post here>>.
Final Thoughts
As a multifamily investor, depending on how many units your property has, how long you’ve held the property, and what your goals are, your tax strategy might look different. However, there are often some expected tax benefits in owning a multifamily home and various different rules that you can use to lower your tax bill. To get professional advice for your unique situation, and to ensure you have all of your bases covered, we highly recommend working with a knowledgeable CPA. If you want to learn more about multifamily investing and are looking to build your portfolio, we’ve got you covered. Check out our Ultimate Guide to Multifamily Investing to get our list of the best multifamily markets, how to find higher returns on investments, and more.
