P.O. Box 2869, Jackson, WY 83001
K-1 Towards W-2 Income in Multifamily
NOTE: PLEASE SEEK THE GUIDANCE OF A TAX PROFESSIONAL. THIS DOES NOT SERVE AS LEGAL OR TAX ADVICE.
There are two sure things in life- death and taxes. Annually we submit to paying taxes, on top of what has already been taxed from our paychecks. High-income individuals know this pain. But what if there was a way to reduce your taxable income? Real Estate investing has great tax benefits and through passive paper loss, it is possible to save money that would otherwise have to be paid to the government.
Passive Paper Loss is reporting a financial loss on paper from investing in any trade or business enterprise in which the investor is not a material participant and can be filed through the use of K-1’s. A K-1 is a tax document that reports the income, the losses, credits, and dividends of each investor’s share of the investment. Depending on your real estate investment situation, you may receive a K-1 in the mail and wonder if that could be something you can use to offset some of your taxes and the answer is yes, you can!
How can you use depreciation on K-1 towards your W-2 income?
Let’s first emphasize this one fact- although we are claiming losses on paper, we are not actually losing money in real life! Depreciation is legally acknowledging the decrease of an asset’s value due to wear and tear throughout the years on paper, even though in most cases the value of a property actually increases throughout its lifetime due to inflation, value add, and forced appreciation. Depreciation can be legally filed through K-1s (passive paper loss), which are IRS tax forms that are issued annually to those who are a part of an investment in partnerships in order to report their earnings, losses, and deductions of the fiscal year. All individual investors receive a K-1 form from their partnerships to report on their tax returns.
*Your W-2 reports how much money you earned from your employer as well as how much tax was withheld on your behalf during the tax year. If you have a W-2 income you have an active job. This is non-passive income. When tax season rolls around you will receive your W-2 from your employer*
Suppose you buy an investment property. In order to add value to the property to put on the market, you do renovations. You change the paint color, add new appliances, redo the flooring, etc. Say this all costs $80,000, but it increased the value of the property by $130,000. All these things can be filed for as losses in your taxes, although in actuality they are increasing the value of your property. Your K-1 will show all these “losses” and offset your taxable income. And according to the IRS, generally a real estate property has a useful life of 27.5 years. This means that every year for 27.5 years, that property will decrease in value the same amount- which can be filed in your taxes, on top of all other “losses.” This depreciation can amortize the amount of money spent on the renovations.
Cost Segregation in Multifamily Investments
In order for multifamily investors to generate massive savings, they pay for a cost segregation study to be done on the assets that depreciate at an accelerated rate. Since the accelerated depreciation assets usually have a lifespan of 5-7 years, that is the same time frame in which investors get their tax deductions which leads to greater, quicker cash flow. For bigger investments like multifamily properties, cost segregation studies are greatly advantageous. Instead of a property decreasing in value steadily throughout its useful 27.5 year life, these studies accelerate the depreciation of assets. For example, a dishwasher could fully depreciate in 5 years and investors can claim their tax deductions quickly. This could all as well be filed for passive paper loss.
To learn more about saving money through depreciation and cost segregation, check out our blog: https://primeinvestmentllc.com/depreciation-in-multifamily-real-estate/
Can you use your K-1 losses to offset your W-2 income?
Yes, but the IRS does have set rules and structures for this to not be misused. K-1 losses can only fully offset your W-2 income if you have an Active Annual Gross Income (AGI) at or below $100,000. Between $100,000 and $150,000, you can offset a percentage of your W-2 income with K-1 losses. If your AGI income is above $150,000, you can no longer offset W-2 income, but you can cancel out all your real estate income with losses.
So, let’s reiterate: Your Active Annual Gross Income (AGI) is your total salary before tax deductions.
- If your W-2 AGI is less than 100k, you are able to claim up to 25k in passive paper losses.
- If your AGI is between 100k-150k, the 25k reduces accordingly.
- If you make over 150k, you can reduce your AGI if you are a Real Estate Professional
Now, what are the Real Estate Professional Qualifications?
- You work 750+ hours a year in Real Estate
- More than 50% of your working hours are performed in Real Estate
- Materially participate throughout the year on a consistent and substantial basis
If you meet all the criteria- then you qualify as a real estate professional and are able to use the tax deductions in this category. Usually, it is easiest for those who are actively working full-time in real estate related activities. But of course, this is not legal or tax advice. Please seek the guidance of a tax professional and/or consulting a real estate CPA to determine what best works for you and your situation.
Example of a high income earner who is a real estate professional:
A Chief Financial Officer (CFO) makes $325,000 and pays out $113,750 in taxes a year (at 35% tax rate). He has no real estate investments that can reduce or offset his taxable income. After taxes, his take-home pay will be $211,250.
On the other hand, if this same CFO did have investments in multifamily and became a real estate professional, he would still make $325,000 but will actually be able to reduce his taxable income by using the K-1 loss that comes from his multifamily investment. The K-1 loss of $95,000 reduces his taxable income to $230,000 and places him in a lower tax bracket. His taxes are reduced to $73,600 (He is now being taxed 32% instead of 35%). His take-home pay is $251,400.
In these 2 scenarios, there is a difference of $40,150 in tax payments by using the tax advantages of multifamily investing.
How can you take advantage of all of this?
Here at Prime Investment we work diligently to enhance your income and in the process are able to legally deduct and offset some taxes. We are on mission with our partners. Our management team will operate the assets at peak efficiency to ensure a regular, passive income stream for you. Besides investing, you do not have to bother about anything. Simply reap the benefits.
Join us now: https://primeinvestmentllc.com/investor-signup/