Reducing Your Tax Liability as a Multi-Family Real Estate Investor

Real estate investors generally want to do everything possible to maximize their return on investment when investing in residential rental properties. One of the most effective methods of accomplishing this is by reducing their income tax liability on the investment properties they own; this can be accomplished by conducting a cost segregation study.

Per IRS guidelines, residential rental property has a recovery period of 27.5 years. This means the property’s depreciation deduction is calculated by dividing the tax basis by 27.5. For example, a property with a tax basis of $5,000,000 can take approximately $181,818 in allowable depreciation deductions each year over the next 27.5 years ($5,000,000 / 27.5 yrs. = $181,818/yr.).

The purpose of a cost segregation study is to identify, segregate, and reclassify the various assets of a residential rental property into four separate categories:

By allocating the costs to the various asset classifications and depreciating them over a shorter period of time, your tax liability is significantly reduced, and your cash flow is greatly increased. However, you will pay more in income taxes later when the deductions are no longer available, since they were front-loaded to the earlier years of the ownership of the property.

With the Tax Cuts and Jobs Act of 2017, bonus depreciation rules also created a great opportunity for accelerating deductions by increasing the bonus depreciation percentage on property with a useful life of less than 20 years to 100%. Starting in 2023, 100% bonus depreciation begins a five-year phase-out until it is set to be eliminated in 2027. Learn more about the bonus depreciation phaseout.

Here are some actual results from cost segregation studies Withum has completed.

A taxpayer recently renovated a multi-family rental property for $1,000,000. Withum was able to identify approximately $280,000 of assets eligible for the 100% bonus depreciation, resulting in increased cash flow from the income tax deferral of approximately $112,000.

A taxpayer recently purchased an apartment complex for $18,600,000. Withum was able to identify approximately $3,100,000 of assets eligible for the 100% bonus depreciation, resulting in increased cash flow from the income tax deferral of approximately $1,100,000.

A taxpayer recently purchased an apartment complex for $65,300,000. Withum was able to identify approximately $10,400,000 of assets eligible for the 100% bonus depreciation, resulting in increased cash flow from the income tax deferral of approximately $3,800,000.

Author: Nick Dooley, CMEA | [email protected]