Our Insights

Title: How can Multifamily Investors Pay Little or No Taxes on Their Profits

Every real estate investor wants better returns on his or her investments, even multifamily property investors, who want to profit from their assets.  Multifamily investors are often able to pay little or no taxes on their profits because the IRS allows them to depreciate their properties over a period of years, which reduces their taxable income. In addition, there are several strategies that can be used by multifamily investors to defer paying taxes on their income from rental properties.

Multifamily properties offer investors a number of benefits beyond the simple ability of  building passive income through real estate. They allow you to leverage your investment portfolio by diversifying with multiple properties and tenants, which can help minimize your risk exposure. Plus, multifamily properties have the added benefit of being able to provide passive income through rental income, which can be used for other purposes.

However, when it comes time for an investor to sell a multifamily property, there are many questions about how much tax will be owed on the profits from the sale.

This is how multifamily investors get taxed:

Capital Gains Tax – This is triggered when the property owner sells at a profit. The difference between what was paid for the property and what was received from its sale is considered taxable income. Capital gains taxes are typically lower than ordinary income taxes, but they still have to be paid.

Income Tax – Some investors may not have to pay capital gains tax because they have depreciated their assets over time using depreciation deductions (or other methods). In this case, only any income generated by the property after it was purchased would be subject to income tax – and only as long as it exceeds what was previously paid as depreciation deductions during ownership.

Tax Reduction Tactics 

1. Operating Expenses
   If you’re a multifamily investor and want to pay as little taxes on your profits as possible, it’s imperative that you keep track of all of your operating expenses.
   The IRS allows you to deduct these expenses from your total income before determining how much tax should be paid on that income. This can dramatically reduce how much tax is due at tax time.

1. Depreciation Deductions
   Multifamily investors can also reduce their taxes by claiming depreciation deductions on their rental property. Depreciation is an accounting method that allows you to deduct a portion of the value of an asset over its useful life. This is another way to lower your taxable income each year.
   Let’s say you buy a multifamily property for $1 million, but it only costs you $800,000 after closing costs, repairs and other expenses. In this case, you can deduct 20% (or $200,000) in depreciation each year. So if your property generates $10,000 in positive cash flow every year, only $7,000 of that would be taxable income. The rest would be sheltered by the depreciation deduction.
   In addition to lowering taxes, depreciation can also help boost your return on investment. If you keep up with maintenance and make improvements over time, your building will retain its value better than if you hadn’t depreciated it at all — which means more equity for you down the road!

1. Capital expenses (“Capex”). Capital expenses are one of the most underutilized tools for reducing taxes in multifamily investment properties. Multifamily investors can reduce their taxes by deducting “capital expenses” (also known as “capex”). These are expenses that improve the value of the property but are not considered to be part of normal maintenance, repair and replacement costs.
   For example, if you build a pool or an exercise room in your apartment complex, those expenses will be deducted from your income as a capital expense. If you buy a new roof for one of your properties, that purchase would also qualify as a capital expense. 

1. 1031 Exchange: The 1031 exchange is a powerful investment vehicle for taxable investors. It allows you to sell a property, roll the proceeds into another similar property and defer any taxes on the sale. While it’s not necessary to use this tactic to be profitable in multifamily investing, it can help reduce your tax bill if you do. The IRS allows you to defer paying taxes on the gain from the sale of the property if you reinvest your proceeds into another qualified property.
   1031 exchanges allow investors to sell an asset and reinvest the proceeds into another, similar property without paying taxes on any gains. This is accomplished by selling the old property, either directly or through a broker, and then buying another property before their tax return is due. The IRS has strict guidelines that must be followed in order to qualify for a 1031 exchange, including:
   The properties must be held as part of a trade or business (not just investment)
   Both properties must be “like-kind.” This means they have similar characteristics — such as location or type — but do not need to be identical.
   The exchange must be completed within 180 days of closing on the sale of the first property (this includes time spent waiting for title searches).

Cost Segregation

Multifamily investors and property managers can use cost segregation to pay little or no tax on their profits.

Cost segregation is a process that allows businesses to identify and separate out the building components that are depreciable from those that are not. This process helps companies maximize their tax deductions, which in turn helps them keep more of their profits.

The IRS  allows taxpayers to depreciate many building improvements over a shorter period than the building itself. By accelerating the depreciation deduction for some items, you can reduce your taxable income by as much as 40%.

Cost segregation is a simple but powerful tool that will help you save money on your taxes while increasing cash flow for your business.

Summary:

Multifamily real estate has proven time and time again to be a successful investment for the small business owner who desires passive income. A key element to such success, however, is knowing how to achieve this objective without incurring taxes on profits made in a selling effort. There are ways to structure an exit strategy that will allow a real estate investor unlimited earnings with limited taxation. Such scenarios can be executed by incorporating an LLC and potentially utilizing the tax code 1031 to defer paying taxes on capital gains. In order to succeed in real estate investing, you need to know the tricks of the trade or find someone who does.

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Terra Equity Group is excited to introduce our new investment structure for Terra Villa Parks. We would like to introduce you to the new Class A1 and A2 structure. Class A1 will be reserved for those who invest a minimum of $250,000. These investors
will be provided with a projected preferred return of 8% as opposed to the standard (Class A2) 7% offered for this property.

Terra Equity Group is excited to introduce our new investment structure for Terra Villa Parks. We would like to introduce you to the new Class A1 and A2 structure. Class A1 will be reserved for those who invest a minimum of $250,000. These investors
will be provided with a projected preferred return of 8% as opposed to the standard (Class A2) 7% offered for this property.

Terra Equity Group is excited to introduce our new investment structure for Terra Hill Estates. We would like to introduce you
to the new Class A1 and A2 structure. Class A1 will be reserved for those who invest a minimum of $250,000. These investors
will be provided with a projected preferred return of 8% as opposed to the standard (Class A2) 7% offered for this property.

We invest in multifamily and commercial real estate, building better communities for our tenants, and yielding higher returns for accredited investors.

Tax time is perhaps one of the most controversial “seasons,” for hard working business owners and professionals across the country. And to us at Terra Equity Group, that’s unfortunate. We believe that everyone “should” be looking forward towards this time of year – especially our investors.

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In 2019, multifamily investment reached $184 billion, the highest ever recorded, led by single-asset purchases, which are considered the best indication of investment momentum. That momentum was frozen by the start of the COVID crisis in the United States in the first quarter of 2020. Now entering Q4, trading and development are gaining steam once more and capital is available again, largely credited to Fannie Mae, Freddie Mac, FHA, and private investment. The government’s stimulus package with increased unemployment benefits in Q2 helped rent collections remain above 95% throughout the economic downturn.

This year has been unique, to say the least, and the multifamily sector is no exception. Developers are facing new challenges as more families are working from home and others are dealing with job loss and unemployment. In total, however, the multifamily market has remained strong and is even seeing new opportunities for growth in the wake of more severe damage to similar property markets, such as retail and hospitality. This advantage presents opportunities for individuals who are still in a position to invest in the third and fourth quarters of 2020 while private investment is still leading the charge in the multifamily market.

COVID-19 caused global chaos in the business and investment sectors in 2020. So much so, the multifamily real estate investment sector, known for its resilience, could not escape the wrath of the pandemic as well.

According to Forbes, multifamily real estate remains strong amidst economic uncertainty due to the COVID-19.

Let us look back at the pre-COVID-19 era; the U.S. multifamily markets enjoyed a decade of investment flows and improvement since the big recession in 2007.