Are you a high-income earner stressing out about high tax payments? You might feel like the tax benefits of multifamily investments are out of reach. However, this is not true. With a little research and some help from a professional tax preparer, you will be able to get tax benefits from several aspects of Multifamily Real Estate investments When you invest in a multifamily property, you’re investing in more than just the structure itself; there are many tax advantages that come along with it, too These can help you reap profits in the short term and the long term. In this article, we’ll examine how you can take advantage of the five tax benefits of multifamily investments. Let’s get started!
1. Depreciation write-offs
One of our favorite tax benefits for high-income earners is depreciation. The depreciation allowance is a great feature of owning rental property in general; however, it can be better in multifamily investments. The allowance gives you a break on your taxes by reducing your income by the amount of the property’s depreciation expense. It’s possible to write off a portion or even all of your real estate investment over its useful life. For example, you could purchase a multifamily property for $1 million and plan on holding it until it appreciates in value. Depreciation could be a good reason to treat that property as an asset with an expected return—and one worth buying. In addition to depreciating your building over 27 1⁄2 years (39 years if you have commercial property), you can also depreciate any equipment and fixtures you purchase within a year. However, those are capped at $25,000 total per asset category. Many investors realize significant deductions right away but neglect to capitalize on depreciation. For example, if your investment property is worth $200,000 and you make a 20% down payment (which will be tax-deductible), that means you’ll owe taxes on an adjusted value of $160,000. But if your capital cost allowance (CCA) rate is at least 35%, that means you’ll get to write off around half a year’s worth of rent ($8,500) in one year alone! As long as it is used productively for business purposes like commercial rentals or home-based office space, there are few limits on what you can claim.
2. Rental income deductions
Your rental property will have immediate deductions in such areas as depreciation, mortgage interest, and real estate taxes. This is because these items are considered ongoing expenses and must be paid whether or not you collect any rent. This is a huge perk—and it’s not just limited to wealthy investors. For example, if you rent out a room in your home (and you meet certain conditions), you can deduct related expenses, too.
The amount of deductions you can claim on rental income depends largely on the type of property you own. For many high-net-worth investors, the most valuable deductions are found in apartments and co-ops. When you rent out these types of properties, they come with a load of deductions that you can take advantage of.
These same deductions are available to anyone who owns an apartment or co-op, whether or not they receive any income from the property. That means there doesn’t have to be a tenant occupying that room while you write off those costs against your profits from other investments or business income. However, should you realize any losses on that investment later down the road which is a common occurrence for startups, those non-business deductions could offset any taxable gains when sold at a loss.
3. Passive income tax deduction
The tax benefits of investing in multifamily housing investments begin when you hold an ownership stake in a multifamily property. This means that you get to deduct passive losses associated with your investment, such as those on interest and depreciation. These deductions come from things like depreciation, mortgage interest, and management fees. Because you’re receiving money from continuing to own the property, rather than from an annual paycheck, these types of deductions are only available for passive income earners.
Your passive income tax deduction is separate from active losses, which are more closely tied to your real estate holdings and are not deductible under current law. So, for example, if your property suffered $100,000 in operating costs but only brought in $50,000 in rent during a given year, you’d be able to write off that loss against other income sources outside your real estate business—for example, from a job or interest income generated by further investments.
4. Capital gains tax deduction
If you’re going to invest in real estate, it can help to get a handle on how depreciation works. Once you understand that concept, you’ll be able to use it as a tax-deduction strategy with your own multifamily properties.
Say you spend $50,000 buying an apartment building and then sell it after five years for $100,000. Your taxable income would be reduced by $50,000 due to depreciation. The amount of the capital gains deduction depends on how long you’ve owned the property and how much profit you pull out when you sell it.
As long as you hold onto the property for more than one year—and remember that if you pass away during that time period, there may be different rules involved—you could receive full benefits from capital gains and depreciation deductions at tax time.
If you acquire a property and sell it in less than ten years, your profit may be subject to capital gains tax. This can be especially beneficial if you’ve invested in a real estate market increasing in value.
Since all investment profits are taxed as ordinary income, there’s another benefit. Under current law, long-term capital gains rates (which max out at 20%) are lower than standard income rates (which range from 10% to 39.6%).
5. Property Deductions
Wealthy investors in real estate are eligible for a few special tax deductions that aren’t available to other types of taxpayers. One of these is property tax deductions, which can be used to lower your annual tax bill. Property tax write-offs are an essential perk of multifamily real estate investing—but they’re not always easy to claim.
If you don’t itemize your deductions on your taxes, property tax is just one more expense that reduces your profit. To save yourself some work, seek out information on property tax deductions as early as possible and keep these essential facts in mind. For example, if you own a single-family home or condo, any property taxes you pay will likely be fully deductible. However, if you have several buildings (or lots) and pay multiple levels of taxes between those properties and local government—not all of it may be deductible from your taxable income.
Investing in real estate has its benefits: favorable capital gains tax treatment, depreciation deductions, and others. However, as with any investment strategy, understanding your tax burden is critical to overall performance.
Hopefully, this list serves as a starting point for your multifamily investment tax planning. As with any asset class, multifamily real estate offers some unique advantages not present in other investments.
As always, don’t forget to consult with a professional before making any financial decisions.
Falcon Capital LLC is a private equity firm based in Washington, DC that offers investors the opportunity to achieve financial freedom through dependable passive income from commercial real-estate investments.