Multifamily properties are by far one of the best investments that any investor can make in the 21st Century because they offer you the ability to build cash flow quickly while building wealth. Besides these benefits, another awesome reason to get into multifamily investing is the tax advantages that they offer.
In this article, we will break down some of the multifamily tax advantages and offer you strategies that you can use to take advantage of the tax advantages as you build your portfolio of multifamily properties.
Multifamily Tax Advantage
One of the most important tax advantages that investing in a multifamily property offers you is the ability to deduct any depreciation of your property from any taxable income that you will receive from it.
In most cases, the total amount that you’re going to be able to deduct will be calculated as per the Federal Government’s depreciation table and also the MACRS class lives for your investment property.
Most multifamily properties in the United States are often classified as “residential real estate” and are allowed to be depreciated during the course of 27 years. The good news about depreciation is that this term is broad in its definition and includes the total cost of improvements that you’ve made to your building and so much more.
Although you can depreciate the value of your property for close to 30 years, you’re going to also find that cost segregation will enable you to maximize any tax benefits that you receive from the property. This will help you to improve your cash flow because you can accelerate depreciation over a much shorter period of time.
How could depreciation work for you? Let’s say that you pay $5 million for a multifamily property and the overall basis of the building, minus land allocation was roughly $4,000,000. Now, if you’re going to depreciate the value over 27.5 years, you will be able to deduct about $145,000 per year. Cool right?
Besides the example that we’ve given you above, another benefit that you will enjoy from owning a multifamily investment property is the ability to deduct the cost of interest payments that you will make on your loan. Having the ability to write off interest payments from taxable income is huge because it’s also going to help you with improving your cash flow while easing the tax burden that you may have.
What’s even better is that you also have the ability to deduct any credit card interest that you may pay, especially if the funds were used specifically for repairing your investment property or any other expense that’s related to your property.
Repairs Versus Capital
Another important benefit that comes from owning a multifamily property is the benefit you will enjoy being able to deduct the costs that you will incur from owning the property. These costs may include maintaining, finding, and also retaining tenants.
Also known as “Tangible Property Regulations”, the IRS offers a wide variety of ways that an owner can deduct the expenses of owning a multifamily property. These regulations can be very complex so before attempting to understand them yourself, we suggest contacting your tax planner to assist you with incorporating the right tax strategies into your tax planning.
New tax reforms have recently increased the possible benefits for real estate investors. Trump’s Tax Cuts and Jobs Act introduced a new deduction for qualified income that helps investors and owners of multifamily housing. First, the 20% deduction for qualified business income can apply to some rental properties, depending on the business type and income level of the taxpayer. Some choose to invest in real estate investment trusts, or REITs, which also benefit from this deduction.
The new deduction is limited to single filers earning under $157,500 and married joint filers earning less than $315,000. Be aware that for high-income taxpayers with the rental property, the deduction is limited to 2.5% of the unadjusted basis of qualifying property.
Rental property also provides a bonus for some investors who benefit from passive income. There are limitations for income to be classified as passive, such as how much time and effort you contribute towards the property each year. Passive income has much better tax treatment since you may not have to pay self-employment tax on that cash flow. Self-employment tax can deduct an additional 15.3% from income, with 12.4% going towards Social Security tax and 2.9% going towards Medicare tax.
Another provision of the tax reform keeps 1031 like-kind exchanges for real estate transfers, which allow for capital gains to be reinvested into a similar, more expensive property– without being taxed on the sale of the first property. This is a legal way to temporarily avoid paying tax on the capital gains earned when your property was sold for a profit. By reinvesting it into a more expensive property, you capitalize on the gains with a tax-free advantage freeing up more cash for that next purchase.
Rental properties can benefit from many other tax deductions, in some states, you may be eligible for a tax credit for energy efficiency improvements. Taxation is complex and can lead to trouble with the IRS if not done correctly. To ensure that you are getting all of the deductions and credits you qualify for, including the new ones allowed by the recent tax reform, consider seeking professional advice.
As we’ve shown you throughout this article, there are many tax advantages that you will enjoy when investing in multifamily properties.
If you’re planning your tax strategy for the new year, we encourage you to contact an income tax professional to come up with the very best strategy for your business.