Multifamily offers multiple tax advantages such as, depreciation expense, 1031 exchanges, accelerated depreciation using cost segregation etc..several other asset classes such as stocks, funds, etc do not provide. Moreover the sponsors can provide higher returns on the investments by deploying leverage provided by various financing options such as loans from government-sponsored enterprises (GSE) and bank loans.
Depreciation: Apartment buildings have multiple physical components in them such as roofs, HVACs, electrical systems, plumbing, landscaping etc. All these components are capital intensive and have long useful lives. These systems incur wear and tear over time due to operations and to exposure to the elements. Depreciation enables us to capture a portion of the cost of these systems each year as a ‘paper loss’ to accommodate for the deterioration. Our tax code allows to offset our taxable income with these ‘paper losses’ to reduce our yearly tax burdens through out the ownership of these assets.
Cost Segregation: Typically apartment buildings are depreciated in a straight-line over 27.5 years. Cost Segregation is technique that enables us to accelerate depreciation on certain components of these buildings. A cost segregation study, mostly performed by 3rd party experts and/or engineers, categorizes the asset into various components such as land, land improvements, buildings and personal property. Once this study is implemented, the depreciation of these various categories can be accelerated thus providing greater offsets to taxable income in any given year. As part of tax laws enacted in the past few years, Bonus depreciation is allowed for certain categories further enhancing the tax advantages.
1031 Exchanges: Multifamily investments provide greater returns and appreciation of our capital and significant portion of these are realized at the sale of the property. This desired outcome also comes with a challenge of a potentially large tax bill due to the capital gains from the investment. IRS code offers an avenue referred as ‘1031 Exchange’ that allows us to defer the taxes by reinvesting all the gains into a ‘like kind’ asset within a stipulated time. This strategy also provides the flexibility to be deployed multiple times to defer taxes indefinitely while allowing the capital to grow.
While depreciation and cost segregation are two tax mitigation strategies that can enhance higher returns through out the ownership of the asset 1031 exchange is a tax deferment strategy that helps greatly at the time of disposition of the asset. Savvy and experienced sponsors continuously evaluate all the available strategies and deploy them appropriately to ensure higher returns to all the investors legally.