The Other March Madness

What a great time of year! Here in New England, we’re emerging from the darkness of winter. Baseball season has begun. And the college basketball tournament has again left brackets busted.

It’s also tax season…

Wait! Don’t run away! I wanted to share a real-life example of how investing in multifamily real estate can make you a much happier person at tax time.

Keep in mind that I’m not a CPA. Consult a real CPA for tax advice. With that requisite disclosure, check this out…

Each spring, investors in private placements like multifamily real estate syndications receive a tax document called a K-1. The K-1 simply tells your accountant and the IRS how much income your share of the investment generated for the tax year.

What’s important to understand is that the income you report is NOT equal to the amount of cash you received. The main difference is due to the power of depreciation. The Tax Cuts and Jobs Act of 2017 expanded the scope and timing benefits of accelerated depreciation for real estate assets. See more detail from the IRS here.

Say you invest $100k in a multifamily syndication in January of 2018. If the investment delivers its full 8% preferred return, you will receive $8,000 in cash for the year. But, when it comes to tax time, it’s possible that your investment might actually show a loss!

That loss can be used to offset any other passive income gains you’ve received. If you can’t use it this year, you get to roll it over to next year.

K1 tax return showing negative income and distributions.
K1 tax return showing negative income and distributions.

In fact, here’s an actual example of a K-1 I received recently for a $50k minimum investment in an apartment building last year. Keep in mind that we closed in June, so the amount of cash I received was $2,239 (roughly on track for 8% annually). But as you can see in this image from my actual K-1, my taxable income for the year is NEGATIVE $32,348. That means that because of depreciation and other non-cash expenses, the passive income (real cash) received is tax-free.

Some of you more advanced readers will ask if you’ll now have to pay more in capital gains when the property is sold. The answer is yes, no and maybe.

Yes, you will have a larger capital gain because depreciation reduces your cost basis. And no. While the amount of the gain is larger than it would have been, the rate of tax on long term capital gains (0%, 15% or 20%) is typically lower than your marginal income tax rate. So the rate of tax is lower AND you’re deferring the gain into the future. Both better situations.

As for the maybe…

There are advanced strategies you can use upon sale, such as the 1031 exchange, that may allow you to roll that gain into another multifamily investment. But that’s a topic for another post.

If you or someone you know would like to learn more about generating passive income by investing in apartments, please give us a call at (207) 619-1043 or email us at info@