Real estate investors have become intimately familiar with laws that help reduce their tax burden each year. From the outside, it seems like they’re playing by different rules - and in some cases, they are. There are many tax laws that apply only to real estate and provide huge tax advantages, but can't be leveraged for investments like stocks or crypto.
When you consider that real estate is already widely accepted as one of the most secure investment types, the tax advantages compound those benefits and gains for real estate investors. This is why it’s become the most common investment vehicle to offset taxes and build wealth.
Even though real estate offers many tax benefits, today we’ll focus on depreciation and bonus depreciation (via cost segregation study), and how passive investors (Limited Partners) can reduce their taxable income when investing in multifamily syndications.
*First, a quick disclaimer - I am not a tax professional, and this is not tax advice. Please consult a qualified CPA before making any tax-related decisions.
Depreciation
Depreciation is the reduction in value of a physical asset over a scheduled amount of time. Understanding the asset’s depreciation schedule is important because it’s used to reduce the amount of tax exposure an investor has on that particular investment.
With multifamily investments, the IRS allows a depreciable schedule of 27.5 years. The annual deduction is the purchase price divided by its useful life. A $1M apartment building (excluding the land value) has $36,363.64 of depreciation each year ($1,000,000 / 27.5 years).
The benefit of depreciation may look odd since it’s common for a cash-flowing property to look like it’s losing money. However, because of depreciation or paper loss, the property generates real tax-free income for investors.
In a multifamily syndication, this depreciation is passed through to Limited Partners, and eliminates the taxes paid on distributions throughout the hold period. Additionally, depending on the investor’s professional status, they could eliminate taxable income altogether. An example is if the investor, or their spouse, qualifies as a real estate professional (qualifications of a REPro). The real estate professional status allows paper losses from your passive investments to be deductible against your ordinary income (W-2 income) without limits.
Bonus Depreciation
In addition to straight line depreciation, bonus depreciation is an accelerated form of the depreciation schedule that allows an investor to immediately deduct a large percentage of the purchase price of eligible assets, considered “personal property” in the same year the expense is incurred (these include items like appliances, plumbing fixtures, windows, cabinets, etc.).
By claiming bonus depreciation and deducting the entire cost of the eligible assets in a single year, an investor is able to reduce taxable net income to $0 and may be able to carry forward the loss to use as a deduction in future tax years.
Bonus depreciation is currently set to phase out by the end of the 2026 tax year, and 2022 is the last year investors can claim 100% bonus depreciation, assuming Congress doesn't change the law before then.
When you consider the below tapering schedule for bonus depreciation, passive investors are frantically searching for investment opportunities that offer bonus depreciation.
Cost Segregation A cost segregation study is a 3rd party analysis of a property and a “segmentation” of its components into different buckets that can be depreciated at an accelerated rate. The study is conducted to accelerate the depreciation process to calculate the bonus depreciation. This requires hiring a private engineer to evaluate the value of the personal property, with the goal of finding the total value of these items and depreciate it over the same 27.5 year period.
The result is additional allowable depreciation and a maximization of the tax savings annually. We use this strategy in all our investments to provide our investors with maximum possible returns and tax benefits.
Summary
Depreciation is a powerful tax deferral vehicle of multifamily investing. In a time of economic uncertainty, stock and crypto volatility, and inflation, investors are finding strong returns and tax advantages with multifamily syndications.
If you are ready to capitalize on these benefits, schedule a call with Minyum Capital to learn more about current offerings, and discuss how depreciation can offset your taxable income.
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