Updated: Jan 9
For many passive investors, multifamily properties are where the action is. Multifamily investing has skyrocketed over the past several years and shows no signs of a letup in the incredible growth of this sector. The fervor that fueled the single family home market’s “buy, fix and flip” approach has given way to investors making solid investments in multifamily housing.
It’s all happening for very good reasons, and everyone wants to participate. Unfortunately, this insatiable interest is driving up the prices of multifamily properties to levels that have never been seen before. Despite the huge price increases, the demand for multifamily properties hasn’t lessened at all, which is further compounding the problem. So how did this all happen, and how did multifamily properties become the darling child of investors?
It Starts with the unique Benefits of Multifamily Investing.
One of the biggest benefits of investing in a multifamily property is the leverage it provides the investors. A passive investor can put up an amount as little as $50,000 or $100,000 and be involved in a property worth over $1,000,000. In addition, the investor can benefit from ongoing cash flow, potential asset appreciation and can also participate in exceptional tax benefits. Because of these factors, lenders are willing to lend money for the purchase of multifamily properties, as their risk is minimized.
Perhaps the biggest benefit of all for multifamily investors is the tax benefits bestowed by the IRS. And it all begins with depreciation.
Over the years, multifamily properties tend to increase in value, and thanks to vigilant upkeep and maintenance their useful life goes on for a long, long time. To make sure that enough capital expenditures are made by property owners to do the necessary maintenance, the government allows multifamily owners the ability to take depreciation deductions against current income each year. The amount allowed is equal to 38% of the property’s value when it was purchased.
Why 38%? It’s the equivalent of 1/27.5, a number that is based on the 27.5-year lifespan the government places on a multifamily property. Here’s something else: every time the property is sold, the 27.5 years starts over again. With most properties, the depreciation deduction helps eliminate almost all of the current income, so investors often gets a cash distribution while showing on loss on his or her tax return.
As if that wasn’t enough, you can even do a cost segregation study that can speed up the depreciation of various assets within the property, such as doors, window, appliances and more. Not every single item in a multifamily property has a 27.5 lifespan. But cost segregation studies can be expansive, over $10,000 and more. So it depends on the property whether or not the cost justifies doing the study.
Investors get to enjoy another benefit from multifamily real estate - passive income tax status. Just as long as you’re an investor and not the syndicator of the deal, income from a multifamily property is taxed at lower passive income rates. This income is exempt from employment tax and their rates are lower than current income tax rates. So if there is any taxable income to be distributed after the depreciation is taken, it will be taxed at the lower passive income rate. Here’s