Since we are now officially in tax season, I’m sure many of you are wondering how to protect your wealth from it being taken by the IRS. I have covered some of the tax benefits when it comes to multifamily, but I want to go a little deeper in the benefits and what it means to you as an active owner or a passive investor.
Before I go into the 4 most powerful tax advantages of multifamily investing, please note that I am not a CPA or a tax attorney. All this information is based on my personal experience and advice from my advisors on deals. Really, this is a birdseye view of the most powerful tax benefits that any passive investor should understand and you should talk to your own tax planning advisors and strategists before executing these tactics.
1) Depreciation When you own or are invested in a multifamily deal, you are technically invested in a business. So everything related to that business, from paperclips to taxes, can be written off. One of the most powerful deductions you can write off is depreciation.
This is how a straight line depreciation schedule works: The IRS ruled that resident-occupied real estate has a lifespan of 27.5 years. The land the property sits on cannot be depreciated as it has an infinite lifespan. Let’s say you want to buy a property for $6MM and the land is worth $400k. Applying the IRS rule, you are able to deduct 1/27.5 of the $5.6MM, or $203,636 from income for each year. This allows you to show a loss on paper as the deduction may eliminate most or all of the income from that property. Even though you show a loss on your tax return, that money is cash in your pocket and that of your investors.
If you have a portfolio of other investments, you are then able to apply these paper losses to other areas of your portfolio. This means that your multifamily investment can lower your tax exposure on other investments you hold. Even as a passive investor on one of our deals, the depreciation in our multifamily deals flows through to our investors in proportion to their ownership percentage.
Keep in mind that I am not saying that it is not an entire elimination of all taxes. But there are other tools you can use to defer taxes indefinitely and even accelerate depreciation
2) Cost Segregation Cost Seg is a great way of accelerating the depreciation of just about any commercial property – including multifamily. As I mentioned earlier, the IRS tax code says that real estate has a lifespan of 27.5 years. However, there are certain items that make up the building such as the plumbing fixtures to the cabinets to the appliances, that have a shorter lifespan.
When a professional cost segregation study is performed, an engineer will come on site and walk each individual unit. From there, they will separate all the items from the overall value of the building and present you with a schedule for those individual items. Many of those items, the IRS deems them to to have up to 7 years of useful life. The cost segregation study identifies these items.
In the previous example, I indicated that you would save $203,000 in taxes through depreciation. Let’s say that the cost segregation study of that $6MM property shows there is $5MM in building depreciation and $1MM from personal property appreciation. Your taxes look a lot different. We would take the ($5MM x 1/27.5 years) for $181,818 and ($1MM x 1/7 years) for $142,857, totalling $324,000 in annual depreciation expense – a significant savings over the $203,000 that we had calculated before! This will give you a great tax offset in income against other investment income.
The only caveat with taking this approach is that you could get hit with a higher tax bill when you go to sell the property down the road. As I mentioned earlier, there are ways of rolling your gains without getting nailed on taxes.
3) Qualify as a Real Estate Professional For many people, real estate is a means to supplement their full-time job with some additional income. What many don’t know is that if you spend 750 hours or more annually in your real property business, such as managing rentals or turning units, you qualify as a Real Estate Professional. This means you are able to deduct 100% of your rental depreciation and ‘losses’ against any other income. This designation only helps you if you have ownership in a significant amount of rental property (i.e. more than just 1 unit) and you earn less than $150,000/year in Adjusted Gross Income. If you are an investor in one of our deals, you then have ownership and that may get you qualified.
4) 1031 Like-Kind Exchanges Earlier, I mentioned depreciation as a way to increase your deductions and reduce your gains. A great way to defer taxes on your gains is by using a “1031 like-kind exchange” to roll your gains and avoid getting nailed in taxes for an indefinite amount of time. As long as that cash stays in the 1031, you can keep multiplying it without any tax implications.
This is one of the most powerful tools when it comes to deferring taxes and saving you a lot of money. The first thing to know about doing a 1031 is that when you roll the profits from your real estate project, it must be put into another real estate project like the one it was in previously. This means you cannot take the profits you made on that multifamily deal and roll it into a new pizza place you want to start up. You would need to roll that cash into a higher-basis property within a set timeframe. Talk to your CPA about lining you up with a professional 1031 intermediary.
Anyway, have you heard of these tax advantages? Let me know in the comments. I’d love to hear from you.
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Whether you have owned your property for a while or just taking it down today, there are many ways of boosting revenue. Keeping an eye out for opportunities to increase income is not only important to cash flow, but also to improve the overall valuation of the property.
Here are my 5 ways of boosting the revenue of your multifamily deal:
Reduce Turnover: One of the best ways of reducing expenses is to keep your turnover as low as possible. Churning through tenants increases your costs simply because you need to turn the unit every time they leave. Even if we are talking cleaning, paint, or a carpet cleaning, you have to hire the contractors, plan, and do the work. You then need to advertise and qualify the incoming tenant. This can shave weeks or even months off the income for that unit.
You want to carefully underwrite the tenant almost the same way you underwrite your deals. You want people that will pay consistently and have a good background. The right tenant will also take care of the unit and will not disrupt others. Also, by employing what I call “attentive property management” you can keep the tenants happy and cash flowing. This means tending to problems reported by the property manager and showing you care about the tenant. Sending birthday and holiday greetings goes a long way to letting them know you appreciate them.
Increase Rent: This is an obvious way to increase revenue, but it must be handled carefully. You must analyze the rents in the area as well as the amenities of your competitors. If your units do not have the same finishes or upgrades as the units in the local market, there may be an opportunity for you to improve the units and bump rents. Keep a close eye on the economic cycle as well. If your region of the country or city is beginning to experience a slowdown, you want to make sure you can make the improvements and still increase the rents.
Regular maintenance is important to increasing rents and sustaining the investment in the property – all while creating value for the tenant. If you are planning to add a stainless steel microwave or replace one of the major kitchen appliances, you may choose to coordinate the replacement with the lease renewal so the tenant sees the value for the additional bump in rent.
Fees: There are several fees you can apply to a tenant, always being careful not to cost yourself out of a tenant. In some markets and asset classes, you can get away with charging an application fee. Additionally, you can also charge a non-refundable pet fee of $200 at the beginning of the lease, for example, along with a small recurring fee of $10/month for small pets. There are also late fees, but you need to be careful that this is not indicative of a larger issue the tenant is having in their life, like a job loss. Not charging them tells your tenant that its okay to be late, so make certain you do this. If you are renting individual rooms, you may choose to charge a “roommate change out fee”, which would include an admin and re-application fee of the new tenant. Something similar to this is a “lease change fee” for replacing someone on the lease or for subletting. Talk to your attorney about applying these fees in your area and the language to add them to your lease.
Vending: Selling everything from snacks to toiletries to tenants is not only a convenience for them but can drastically increase your cash flow. In some properties, I’ve seen vending machines that sold cold sandwiches and fresh fruit next to a machine that sold hot entrees. Those machines were set up in a senior housing apartment. In other places, I’ve seen laundry detergent, dryer sheets and even toothpaste sold in these machines. Be careful of where you place these machines as you want to make it easy for tenants to get to, yet not disturb others for tenants that are looking for a midnight snack. Also, make certain you have cameras on the vending machines as well.
Other Services: Depending on the asset class, you can offer a host of other services such as house cleaning. You can work with a house cleaning contractor and put in a bump so you make a profit. You can hire a cleaning service to come and clean the unit for $50 every two weeks while charging your tenant $175/month for the service. This increases your revenue by $75/month or $900/unit annually. Another option is door side trash pick up which is a great amenity to add to your apartment community. It helps better secure the comfort of your tenants stay and add to the value of the property.
Anyway, here are my 5 of ways to boost the ROI of your property while improving the overall valuation of your investment. What are you doing to find additional revenue streams in your properties? Let me know in the comments. If you like the content, check out our podcast on iTunes and Stitcher and subscribe to the new YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.
With a tight multifamily real estate and little inventory, knowing how to pick a market to invest in is crucial. Here are five things you should be looking at to select a market.
1. Demographics; Who lives in the area today? Is there a migration of people moving into the market? What is driving the movement?
2 Rent Rates; What are the average rents in the area? Is it a A, B, C or D area? How much are houses renting for (and competing for apartment dollars)?
3. Employment; Are there jobs in the area? Are companies moving in (or out) of the area?
4. Available Inventory; How many buildings are for sale? What is the average cost per door by class? How quickly do they move?
5. Exit; After you get a deal under contract, how many people are also chasing the deal? If you understand this, you just found the people that will buy the deal from you when you are ready to sell.
You can lose a lot of money in real estate if you don’t do your research. You need to learn all you can about multifamily real estate so you can become an informed investor or a master syndicator. It doesn’t matter if you are working on your first deal or your 100th – staying sharp is important and being engaged with the market is key! Know WHERE you are buying and WHY you are buying.
Another thing to note is that multifamily real estate investing is a team sport. Go to live events and network with others. Who knows…you may even find your next deal at your very next networking event!