Passive Investing with Huge Tax Benefits

What if I told you that there is a way to generate passive income while also gaining huge tax benefits? Multifamily investing is one of the best forms of passive investing on the planet! There are a lot of major advantages that we will discuss in this post. Let’s make this simpler by breaking it down into five specific categories:

-Depreciation

-Cost-Segregation

-Passive Income Treatment

-1031 Like-Kind Exchanges

-Death

Keep in mind that the information I’m about to provide should not be used as a legal reference. I’m going to show you the tax advantages of multifamily investing but don’t supplement this for legal advice.

Depreciation

Depreciation is the greatest tax benefit for multifamily properties! These properties appreciate at a steady rate since their value is not influenced by the real estate market. So they will continue to go up in value for decades as long as their upkeep is part of the overall business plan.

Just keep in mind that if a multifamily property is not maintained properly, then it will become uninhabitable.

Any money that you spend on upkeep is considered capital items so it’s taken from income after taxes. However, the government wants these complexes to remain standing as long as possible. As a result, they allow owners to take these expenses as a depreciation deduction. 3% to 4% of the property’s value is allowed to be written off as depreciation. This full amount can then be put into the upkeep of the property.

To put this into layman’s terms, if you were to purchase a multifamily complex valued for $1,000,000, then you would be allowed to deduct $50,000 every year. That amount can then be used as upkeep. For a lot of new purchases, this will actually eliminate most of the income on the property in the eyes of the IRS.

Cost-Segregation

When you invest in a multifamily property, you are allowed to conduct what’s known as a “cost-segregation study.” Here’s how it works.

As we saw in the previous section, the government will consider an apartment complex to have a life of 27 years. But the lifespan of appliances and other items is viewed to be much shorter.

So investors bring in a professional to perform a cost-segregation study. This separates those appliances from the value of the property, so you can generate even higher savings through depreciation.

Just be careful with cost-segregation because it’s possible to take too much depreciation early on in the life of the property. You could be left with a huge tax bill if you decide to sell. Always consult a tax professional before making any final decisions.

Passive Investing Treatment

Passive income is taxed much differently than standard income so as long as the IRS does not define you as a real estate professional, then multifamily investing is seen as passive income.

A real estate professional is someone who spends more than 500 hours in a given year working in the real estate business. If you have property managers in place, then you will not be putting in anywhere near those hours.

All income that is left over after depreciation will be taxed on this lower rate. The government treats passive income as capital gains, which gets preferred treatment.

Section 1031 Like-Kind Exchanges

All of the depreciation deductions that we discussed earlier will reset upon a change in ownership. You recapture this depreciation by filing a “1031 like-kind exchange.” This amount is determined by using the following formula:

Property Sale Price – (Purchase price – accumulated depreciation over life of property)

You can then defer payment of this amount by using that money towards the purchase price of a higher-basis, more expensive property. This is a complicated process that requires a tax professional to pull off.

In short, you are able to use part of your tax payment toward the purchase price of another more expensive property. This is done to encourage investments in newer multifamily complexes.

Tax Benefits of Death

Multifamily investing comes with an additional benefit, one that you never want to experience. But it ensures that your family is secure. When an investor dies, a new tax basis is assigned to any multifamily properties that their heirs received. If the unexpected happens, your family will not be left with all of those gains to deal with. They all disappear.

Let’s assume that you bought a property for $1,000,000 and used the depreciation deduction for 10 years. Rather than passing the property to an heir with only a $900,000 tax basis, it would be reset to $1,000,000.

Important Information to Keep in Mind

If you decide to invest in a syndicated multifamily real estate deal, then make sure that you understand the tax implications. These deals are not eligible for the 1031 exchange treatment that we mentioned above. But there is a way to avoid taxes on syndication deals. You can start an LLC and then keep those funds in that business account. However, seek professional consultation to determine whether this makes sense.

All of the tax benefits of passive investing are available in multifamily property deals. That’s one of the many reasons that it’s an amazing investment opportunity.

- Stuch Capital
stuchcapital.com