Multifamily investing is a great way to invest your money and earn income from real estate.
Multifamily investing is the process of purchasing and managing multiple rental properties. Depending on your goals and financial situation, you can own one multifamily property or several at once. A single-family home is usually not considered a “multifamily” property because it only has one unit, but many people consider duplexes and triplexes as multifamily properties.
Multifamily investing is buying multiple properties you rent out and manage, either on your own or with a team of other investors.
The main benefit of multifamily real estate investing is that you can earn a steady income without worrying about tenants paying their rent or moving out on short notice. That’s because the rents are typically guaranteed by long-term leases renewed automatically every year or every two years.
What Are The Tax Benefits Of Investing In Multifamily Properties?
Investing In Multifamily Properties is a great way to generate passive income, but it also comes with some incredible tax benefits.
1. Depreciation: The federal government allows you to deduct a portion of the cost of acquiring or improving a rental property each year. This deduction is called depreciation and allows you to recover some of your investment over time rather than having it all taxed immediately at its full value. The IRS sets annual depreciation limits based on when you acquired the property. Still, most investors use accelerated depreciation methods that allow them to deduct more costs upfront than allowed under normal rules.
You can depreciate a rental property over 27.5 years (residential) or 39 years (commercial). This means that each year, you can deduct a portion of the cost basis from your taxable income. This reduces your tax bill dollar for dollar.
When you purchase an apartment building or any other type of real estate investment property, you can write off the cost over time using depreciation deductions. Each year, you will be able to take a percentage of the purchase price as a deduction from your income taxes
Depreciation is a helpful tool for balancing positive cash flow created on an investment property, regardless of whether the investor uses a cost segregation study. This is true whether a property is owned wholly or through a partnership.
2.Tax Rates- Ordinary income and capital gains taxes are usually the two types of taxes that apply to investments of all kinds. When the investment generates income, you must pay regular income tax; when the asset is sold, you must pay capital gains tax. Ordinary income tax rates at the federal level can reach as high as 37%, while capital gains taxes typically have a peak rate of roughly 20%. These rates do not consider the passive investor’s 3.8% net investment tax levied on rental income and capital gains. Additionally, states frequently impose additional taxes.
Stocks that provide dividends and real estate cash flows are typical income properties. However, the cash flows created by real estate can be offset by depreciation and interest charges (see above), whereas the income from stock dividends cannot. This crucial difference between the two makes real estate a more advantageous asset class for tax purposes. In other words, interest and depreciation costs are deductions from ordinary income that may result in expected losses.
These factors lead many real estate investors to choose direct ownership of real estate over investing in publicly traded REITs (whether through a fund or another vehicle). Ordinary income tax is levied on REIT payouts, like on distributions from any other stock.
But real estate investors are not exempt from responsibility. Instead, they must pay capital gains tax on the asset when sold, which might be expensive depending on the property’s original basis.
However, there are other ways to postpone paying capital gains tax, sometimes indefinitely.
3.1031-Exchanges: Section 1031 exchanges allow investors to exchange one rental property for another without paying taxes on the gain from selling their old property as long as certain requirements are met. This allows investors to defer capital gains indefinitely by switching out one investment for another without having to pay taxes until they actually sell their current property.
This is especially helpful when an investor has owned a property for a long enough period to exhaust depreciation. Using a 1031-exchange to reinvest the sales proceeds, the investor assumes a lower tax basis in the new asset, which often represents the delayed gain. The investor would have a different cause that may be depreciated if the newly purchased property has a higher value than what was sold.
Although this is a fantastic instrument for capital preservation, because the IRS regulations surrounding 1031 exchanges are so complicated, private investors frequently hesitate to use them. Investors must meet several strict deadlines for the trade to be approved. Usually, expert advice is required.
The management of 1031 exchanges is better suited to real estate private equity groups. The tactic is most frequently employed by funds that perform their own 1031 exchanges or set up tenants-in-common arrangements that provide investors immediate title to the asset. These laws prohibit a limited partner or member of an LLC from trading a real estate partnership or LLC sales distribution earnings.
The Bottom Line
Multifamily investing offers investors incredible tax benefits. When done right, your tax burden and liability can be significantly reduced and even eliminated. When deciding on multifamily real estate for investment, deciding what type of real estate to invest in should also be based on your goals and objectives.