When multifamily investors receive their first K-1 partnership tax return, many assume a mistake has been made. The document shows a loss, yet their bank account shows distributions. This apparent contradiction confuses investors and, according to Steven Libman, founder of Investing With Purpose™, leads them to undervalue one of the most powerful features of multifamily investing.
The disconnect stems from depreciation, a non-cash expense that allows property owners to deduct the gradual wear and tear of a building over time. For residential real estate, the standard depreciation schedule spans 27.5 years. However, a cost segregation study can identify components that qualify for shorter schedules—five, seven, or 15 years—and under 100% bonus depreciation, these can be fully deducted in the first year. As a result, a property can generate positive cash flow while simultaneously producing a tax loss that shelters 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.” The K-1 delivers these losses to the investor's personal tax return, connecting the property's depreciation to individual tax savings.
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, the remaining $50,000 does not expire. It carries forward indefinitely, offsetting future income. “Those carry forward in perpetuity, so that can continue to offset income down the road, not just this year,” Libman explains. “It’s not like if you don’t use it, you lose it. You get to keep it.” Over time, accumulating these losses can create a pool that shelters income for years.
However, using K-1 losses depends on passive activity rules. Most real estate losses are classified as passive and can only offset other passive income, not W-2 wages. But the real estate professional designation offers a path. Taxpayers who spend at least 750 hours annually in real estate activities may qualify, and when married and filing jointly, a spouse's W-2 income can be offset. “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 says.
At Investing With Purpose, cost segregation studies are standard practice, generating the depreciation that flows through to K-1s. The firm treats tax benefits as a bonus, not a core underwriting assumption. “We underwrite the property as a standalone, and then the tax benefit is kind of the cherry on top,” Libman notes. However, depreciation is not a permanent escape; recapture taxes apply upon sale. But investors who reinvest in new properties can generate fresh depreciation, creating a stacked benefit.
Understanding these mechanics is essential for managing capital responsibly. Investors who dismiss K-1s as paperwork may be leaving significant value on the table. For those looking to leverage these strategies, more information is available at Investing With Purpose.
