Multi-Family Properties and How to Maximize Returns

[Julio Gonzalez]

1. Passive Activity Loss Rules

If you are a real estate investor that doesn’t qualify for REPS status (discussed in #5 below), understanding the Passive Activity Loss rules is crucial. Passive activity losses are those losses from activities in which the taxpayer doesn't materially participate. There are some key limitations that are important:

• Passive losses can only offset passive income.
• Up to $25,000 in passive rental losses may be deducted against non-passive income if the investor actively participates and their modified adjusted gross income is below $100,000.
• Unused passive losses are carried forward to future tax years.
• Here’s an IRS article that further discusses the rules: https://www.irs.gov/publications/p925

1. 1031 Exchanges

This strategy allows investors to defer capital gains tax when they sell a property if they invest the sale proceeds into a “like-kind” property. There are specific rules for 1031 exchanges including:

• The replacement property must be identified within 45 days of transferring the relinquished property.
• The replacement property must be received within 180 days after the transfer of the relinquished property or the due date of the taxpayer's tax return, whichever is earlier.
• Special rules apply for exchanges between related parties (defined in § 267(b) or 707(b)(1)).
• Real property located in the United States and real property located outside the United States are not considered property of like kind.

1. Cost Segregation Studies

A Cost Segregation study is an IRS approved federal income tax tool that increases near term cash flow by utilizing shorter recovery periods for depreciation to accelerate return on investment. For newly constructed, purchased or renovated properties and also retroactive generally over the last 10 years, building components are properly classified into individual units of property and accurate recovery periods for computing depreciation deductions. The study identifies with forensic engineering detail the immediate Bonus Depreciation 5, 7 and 15-year personal property class lives qualifying portions of a building that are normally buried in 27.5 year residential or 39 year commercial categories. Here is a great article that walks through frequently asked questions on cost segregation studies: https://www.biggerpockets.com/forums/51/topics/1113749-cost-segregation-faq

1. Partial Asset Dispositions

A partial asset disposition allows real estate investors to write off the undepreciated value of building components that are replaced during renovations or those that are damaged/destroyed. Here’s an article that walks through an example: How a cost seg study helps if an asset gets damaged! (biggerpockets.com)

1. Real Estate Professional Status (REPS)

Qualifying for real estate professional status can be a game changing tax strategy resulting in significant tax savings especially when utilized with cost segregation studies and accelerated depreciation. Here’s a great article that walks you through how to qualify for REPS status.

https://www.aicpa.org/resources/article/tax-rules-for-real-estate-professionals

1. Entity Structure Comparison

Be sure to consult with a CPA or tax attorney as the entity structure you select can have a significant tax impact. The best option for you depends on a number of factors including your exit strategy, any liability concerns and preferred tax treatment.

Type of Entity	Tax Treatment	Main Advantages
C-Corporation	Double Taxation	Corporate tax rates are lower
S-Corporation	Pass-through	Self-employment tax savings
Limited Liability Company (LLC)	Pass-through	Liability protection and flexibility

1. Future Outlook and Recent Tax Law Changes

Most recent tax changes applicable to real estate investors include:

• The increase in the estate tax exemption to $13.61 million per individual for 2024.
• Energy tax incentives were expanded and extended through 2032.

Be sure to keep an eye out for any changes to 1031 exchanges and capital gains tax rates.

1. Buy, Borrow, and Die Strategy

A great estate planning strategy for transferring wealth and minimizing taxes is the Buy, Borrow and Die Strategy.

Buy: Purchase multi-family properties that are appreciating in value.

Borrow: Use HELOCs or cash out refinancing to pull equity out of the property as it appreciates. Utilize the borrowed money to invest in additional properties.

Die: Upon death, your heirs will receive these properties with a stepped up basis which can potentially eliminate capital gains tax on the appreciation that occurred on the properties during your lifetime.

Have you utilized any of these strategies in your real estate portfolio?