Multifamily investors are often puzzled when their K-1 tax forms show losses while their bank accounts show positive distributions. This confusion, according to Steven Libman, founder of Investing With Purpose™, can lead to misreading one of the most valuable features of multifamily investing.
Libman explains that the disconnect between paper losses and real cash stems from a common association between the word “loss” and actual financial harm. In real estate, a K-1 loss typically signals the opposite. The mechanics begin with depreciation, which allows property owners to deduct the wear and tear of a building over time, even though no cash is spent. For residential real estate, the standard depreciation schedule spreads this deduction over 27.5 years. A cost segregation study can identify components eligible for shorter schedules, and under 100% bonus depreciation, these can be pulled into year one.
The result is that a property can generate real positive cash flow while simultaneously producing a tax loss large enough to shelter that income. “When we are trained to hear loss, we think, ‘Oh no, I lost money,'” Libman says. “And in real estate, a K-1 loss usually means the opposite of what’s happening in real life. It just means that it’s a non-cash expense.”
One of the most overlooked features is the carry-forward of unused losses. If an investor generates $150,000 in K-1 losses but only has $100,000 in taxable income to offset, the remaining $50,000 does not expire. It carries forward indefinitely. “Those carry forward in perpetuity, so that can continue to offset income down the road, not just this year,” Libman notes. This turns depreciation into a long-term tax asset, allowing investors to build a growing pool of carried-forward losses that shelter income for years.
However, the ability to use these losses depends on passive activity rules. Most real estate losses are classified as passive, meaning they can only offset other passive income, not W-2 wages. But the real estate professional designation can change that. Under IRS rules, taxpayers who spend at least 750 hours annually in real estate activities may qualify to offset other income, including W-2 income when filing jointly with a qualifying spouse. “If you have a W-2 spouse and you’re a real estate professional, then that depreciation can actually go and offset some of the W-2 income because you’re married and filing jointly,” Libman explains.
At Investing With Purpose, cost segregation studies are run as a standard part of the acquisition process, generating depreciation that flows through to K-1s. The firm treats tax losses as a benefit layered on top of the property’s standalone investment case, not as a substitute. “We underwrite the property as a standalone, and then the tax benefit is kind of the cherry on top,” Libman says. He also cautions that depreciation is not a permanent tax elimination; recapture occurs upon sale, but buying a new property in the same year can generate fresh depreciation, creating a stacked tax benefit.
Understanding these mechanics is essential for investors to manage capital responsibly and avoid costly missteps. For more information on the firm’s investment approach, visit Investing With Purpose.
