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TAX INCENTIVES FOR MULTIFAMILY INVESTMENTS

Exploring tax benefits for investments is crucial, and when it comes to real estate, multifamily stands out as a prime choice. These investments offer stable returns and many tax incentives that can substantially mitigate operational expenses. While the savings amount varies, each incentive presents an opportunity worth capitalizing on.

In this guide, we’ll dive into the diverse tax benefits accessible to both multifamily property owners and investors in real estate syndications. This guide is for educational purposes and should not be a substitute for professional tax advice. Investors should consult with a tax professional to maximize tax benefits within the scope of the law.

Depreciation Tax Benefits

Real estate investment offers a unique advantage through depreciation, a tax benefit that acknowledges the natural wear and tear of assets over time. While real estate generally appreciates in value, the IRS still allows for depreciation tax deductions, similar to vehicles and other assets. This deduction reduces tax liability despite the property’s increasing value.

Depreciation works by recording a yearly non-cash expense as a portion of the property’s value, lowering taxable income without affecting cash flow. The IRS provides guidelines for depreciation periods, typically allowing for a 27.5-year period if the investor abides by limits on interest deductibility. However, depreciation can extend up to 30 years if the investor decides to fully deduct business interest.

Here’s how it works: Suppose you acquire a multifamily apartment building for $4 million, with $800,000 allocated to land value (non-depreciable). The remaining $3.2 million can be depreciated over 27.5 years, resulting in approximately $116,364 in annual depreciation.

Depreciation is governed by specific rules and limitations, including the Modified Accelerated Cost Recovery System (MACRS) and the potential recapture of depreciation upon property sale. Maintaining detailed records and consulting with a tax professional are crucial.

Cost Segregation Tax Benefits

Real estate investors are incentivized to maximize depreciation deductions each year, and cost segregation is a powerful strategy. This approach involves reviewing the property and categorizing its components for accelerated depreciation and decreased tax liability. A cost segregation study should be performed by a third party expert.

Typically, all elements of a real estate investment are depreciable except for the land itself, which is a fixed cost. A multifamily property can usually undergo straight-line depreciation over 27.5 years. However, a cost segregation study splits the property into four categories with shorter depreciation periods:

  1. Personal Property: Items like furniture, fixtures, and window treatments are typically depreciable over five or seven years.
  2. Land Improvements: Including parking lots, landscaping, and swimming pools, these items depreciate over 15 years.
  3. Building Components: Structural elements like roofing and plumbing systems are depreciable over 27.5 years for residential buildings.
  4. Land: Any unallocated amounts end up here. Because land isn’t depreciable, the goal is to minimize this amount.

By reclassifying non-structural items as personal property or land improvements, owners can depreciate them over shorter periods, significantly accelerating depreciation. While cost segregation increases annual tax benefits, please note that utilizing these tax breaks may inflate the tax bill upon selling the property.

Cost segregation is another tax benefit that will increase the ROI of a multifamily investment and help you build more wealth with real estate. Strategic planning and expert advice ensure optimization of this tax benefit within legal parameters.

Passive Income Tax Benefits

Understanding passive income tax benefits is crucial for multifamily real estate investors aiming to optimize returns and minimize tax liabilities. The IRS distinguishes between passive and active real estate activities, with passive investors benefiting from lower tax rates.

Investors who spend less than 500 hours annually on real estate activities are considered passive. By remaining under this threshold, investors can avoid higher federal income tax rates, resulting in substantial tax savings.

Research to determine how many hours you spend on real estate activities and the potential tax savings of becoming a passive multifamily real estate investor. The tax benefit from working less than 500 hours can save you a lot of money annually. By investing in a real estate syndication, you would likely be granted passive status by default.

1031 Exchange Tax Benefits

Derived from section 1031 of the Internal Revenue Code, a 1031 exchange is a tax break that allows you to defer capital gains taxes when you sell an investment property and reinvest the proceeds into a “like-kind” property of greater or equal value.

Consider the specific criteria to qualify for this tax break:

  1. The new property must be “of the same nature or character” as the old one.
  2. Both properties must be used for business or investment purposes.
  3. The new property valuation must be the same or higher value.
  4. The new property must be identified within 45 days of the sale, and the purchase within 180 days.
  5. The tax return and the name on the relinquished property’s title must be the same for both properties.
  6. All the equity from the sold property must be reinvested into the new property. If you pull any equity out through the exchange, you may be liable for taxes.
  7. Both the sale and purchase cannot be exchanged directly with family members or people you have a personal relationship with.

Investors should hire a professional to review the transaction and ensure eligibility. Errors could result in taxable transactions, hurting your bottom line.

For a comprehensive understanding of 1031 exchanges and how to file them, read our full guide here.

Real Estate Investment Tax Deductions

Rental income is taxed as regular income, and the amount depends on your tax bracket. Related business expenses can be used to offset the rental income and reduce your tax liability.

These tax deductions can significantly lighten your tax load. The IRS allows real estate investors to deduct taxes from expenses such as:

  • Marketing
  • Utilities
  • Mortgage Interest
  • Insurance Premiums
  • Repair and Maintenance Costs
  • Property Management Fees
  • Capital Expenses

You can also deduct state/local property taxes on your federal tax return. Seek assistance from a specialist to identify which tax deductions your property qualifies for, as not all expenses can be claimed.

Tax Benefits Of Investing In A Syndication

Real estate syndications, like Yankee Capital Partners, pool investor funds to acquire and manage properties. Investing as a Limited Partner (LP) in a real estate syndication offers additional tax benefits:

  1. Pass-Through Deductions: Multifamily syndications are often structured as partnerships or LLCs, which are pass-through entities. Income and losses are passed through to the investors, who report them on personal tax returns. Profits are taxed at the investor’s personal rate, rather than corporate rates.
  2. Diversification: Real estate syndications often invest in multiple properties, helping investors diversify their portfolio. Investors optimize their tax positions by spreading out deductions, credits, and gains across multiple investments.
  3. Limited Liability: Limited partners in real estate syndications have limited liability, meaning their personal assets are protected from the debts and liabilities of the partnership.

These tax advantages make multifamily real estate syndications particularly appealing to investors. It’s important to note that the specific tax benefits may vary depending on the structure of the syndication, the properties involved, and the investor’s individual tax situation. Consulting with a tax professional or financial advisor familiar with real estate syndication is highly recommended.

Conclusion

By leveraging the various tax incentives available for real estate investments, you can substantially reduce costs and enhance your competitive edge in the market. For accredited investors seeking to capitalize on the lucrative real estate market without the burden of direct ownership, multifamily syndication offers a compelling passive investment strategy.

Reach out to the Yankee Capital team of experts today to learn more about our investment opportunities and returns.

The Top 10 Reasons to Invest in Multifamily Real Estate

We all know we should be investing in real estate, so what is holding you back?

Our team has put together the “Top 10 Reasons to Invest in Multifamily” as a guide for you.

 

 

We highlight some of the many benefits that come with investing in multifamily real estate gathered from our years of experience.

 

 

 

Click HERE to see the full report

 

 

Feel free to reach out to the team if you’d like to learn more, or find more information on how to invest HERE.

Key Takeaways from our Webinar: Tax Benefits from Multifamily Real Estate Syndication

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In our latest Webinar, we shared insights on the tax advantages produced by investing in Multifamily properties. The key takeaways are below.

 

A dreaded tax season just finished after the delay by the federal government. If you are a passive investor in real estate, you received your K-1 and realize the paper loss created by real estate provides lucrative tax benefits.

 

A key addition to the core benefits of multifamily investing, capital preservation, and cash flow are the tax benefits that relate to investing in real estate. The key tax benefits that investors value most are deductions. The most common deductions are as follows:

 

  • Accelerated Depreciation
  • Property Tax
  • Operating Expenses
  • Mortgage Interest
  • Repairs

More Insights

An equity investor through syndication is typically considered a passive investor or limited partner in the partnership. Therefore, the investment is allowed to share in the above deductions based on their proportional ownership interest in the investment partnership.

During the K1 season, real estate companies like Yankee Capital Partners issue K-1 for tax reporting purposes. This does not reflect the overall well-being of the investment. You’ll often receive a paper or passive loss that can offset passive gains in other areas of your portfolio.

An important question we often get is why real estate investors attain so many great tax benefits. The biggest reason is that the government wants us to invest and accelerate the economy.  In turn, the government has paved the way to create tax loopholes for active and passive investors to benefit themselves. These benefits go to entrepreneurs, founders of these entrepreneurs, and real estate investors. The government offers tax incentives in the form of tax deductions to promote their pursuits, thereby stimulating the economy.

The key difference for real estate investors is the gift of Depreciation, which is unique to real estate since it’s an extra write-off. 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, your property generates real income that you take to the bank without paying any taxes on it! The government provides this overall benefit to real estate investors since it needs them to keep building and managing (rental) commercial properties around the country.

 

Depreciation

 

Depreciation is an accounting method of allocating a tangible asset’s cost over its useful life and accounting for declines in value. A common form of depreciation is straight-line depreciation. This allows for equal amounts of depreciation each year. The annual deduction is divided by its useful life, which the IRS considers 27.5 years for Multifamily real estate. This is different from office, retail, and industrial, which have a useful life of 39 years.

 

So, the annual depreciation on a commercial real estate asset worth $1,000,000 is $1,000,000 / 27.5 years = $36,363,64 per year. This does not include the land value

 

As one of the tax benefits of commercial real estate syndications, the depreciation amount is such that a passive investor won’t pay taxes on their monthly, quarterly, or annual distributions during the hold period. They will, however, have to pay taxes on the sales proceeds.

 

Depreciation often accelerates on large commercial assets through cost segregation study.

 

Cost Segregation (Bonus/Accelerated Depreciation)

 

Cost segregation is a strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring income taxes. A cost segregation study performed by a cost segregation engineering firm dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27.5 years, the useful life of a residential building. A cost segregation study’s primary goal is to identify all property-related costs that can be depreciated over 5, 7, and 15 years. As a result, we’ll see significant deductions, which can result in a sizable “paper loss” in the early years of owning the asset.

 

  • Bonus Depreciation: One of the major changes with the Tax Cuts and Jobs Act of 2017 was the bonus depreciation provision, where businesses can take 100% bonus depreciation on a qualified property purchased after September 27th, 2017.
  • Accelerated Depreciation: Accelerated depreciation is any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years of an asset’s life.

 

Capital Gains

 

When you sell the asset, and the partnership ends, passive investors receive the initial equity and profits. Thus, the IRS classifies the profit portion as a long-term capital gain.

 

Under the new 2018 tax law, the capital gains tax bracket breakdown is as follows:

 

Taxable income (individual or joint)

 

  • $0 to $77,220: 0% capital gains tax
  • $77,221 to $479,000: 15% capital gains tax
  • More than $479,000: 20% capital gains tax

 

Cash-Out Refinance

 

It’s common for value-add syndicators to optimize a property’s value (i.e., an apartment) over ~2 years once renovations are completed (higher rents are achieved), go to the bank, and refinance the property since the value most likely increased and pull equity out. There is no taxable event when you return a part of an investor’s equity.

 

1031 Exchanges

 

A 1031 exchange allows one to swap like-kind properties and defer the capital gains tax on the first property’s sale. Most syndications are not set up to take in a 1031 exchange from an investor’s personal property. However, you could do a 1031 exchange from one syndication deal to another syndication deal. This can take place under the same sponsor if that type of opportunity presents itself down the road. Most syndicators will try to make this happen because deferring your investment gains many years into the future is highly beneficial to investors.

 

Self-Directed IRAs

 

A growing number of retirement savers are becoming aware that they can choose investments other than the traditional offerings of stocks, bonds, mutual funds, ETFs, and CDs within an Individual Retirement Account (IRA). Self-Directed IRAs offering non-traditional investments had increased in popularity in recent years and are somewhat more accessible for investors compared to 1974, when the IRA was first introduced. These Self-Directed IRAs allow you to invest in real estate, precious metals, notes, tax lien certificates, private placements, and many more investment options.

 

Investing in real estate through a Self-Directed IRA can be a great way to diversify your retirement account. Traditional and Roth IRAs can change to Self-Directed IRAs, where the individual has more control over what to do with the cash and still has the tax-deferred benefits that an IRA offers. 401(k) plans work a little differently; if the individual is still working for the company that sponsors the 401(k) plan, he or she can’t move the money around. If it’s an old 401(k), a rollover is completely possible. That’s what I did for my first two multifamily investments, having rolled over a traditional IRA to a Self-Directed IRA. The process was fairly easy and straightforward. It allowed me the opportunity to begin investing in multifamily syndication deals as a limited partner.

 

Conclusion

Commercial real estate syndications are highly tax-efficient investment vehicles. The IRS has provided ways to keep more profits in your pocket. These ways can also defer paying the taxes for some time in the future. The ways provided by the IRS applies to:

  • Standard property tax
  • Loan interest
  • Accelerated depreciation opportunities
  • Refinance
  • Potential 1031 exchanges, and
  • Qualified plans.

 

As a person involved in real estate syndications, these are brief summaries and not recommendations or advice. Consult a tax professional regarding your investment situation to learn more about these strategies and how they apply.

 

Access our video on Tax Strategies HERE

As always, if you’d like to discuss any of these points further,
you can reach out to us at info@yankee-capital.com

 

OUR WEBINAR SERIES WILL CONTINUE!

 

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