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As we approach the end of 2023, it's a crucial time for passive investors in multifamily real estate to consider some strategic financial decisions. This year is particularly important due to the changing rates of a tax benefit known as bonus depreciation. Let's explore what this means for you and how you can benefit from it before the year ends.
What is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows you to deduct the entire cost of certain property improvements in the year you make them, rather than spreading the cost over several years. This is particularly relevant for improvements with a useful life of 20 years or less. For 2023, you can deduct up to 80% of these costs immediately, but in 2024, this will decrease to 60%. This makes it a prime time to invest before the year ends to take advantage of the higher deduction rate.
Example of Bonus Depreciation in Multifamily Investments
Consider a scenario where you're part of a multifamily syndication. If the sponsor purchases a $1 million investment property, and then implements what is called a “cost segregation study” which identifies $300,000 worth of components eligible for accelerated depreciation, then these benefits are shared with you. In this example, if you've invested $100,000, representing 10% of the total investment, you would be entitled to a proportionate share of the depreciation deductions. With the 80% bonus depreciation, this could be a deduction of up to $240,000 in the first year. Your share of this deduction would then be up to $24,000 (10% of $240,000), which could be used to offset your portion of the property's income for tax purposes. The actual amounts vary from one investor to another depending on your personal tax situation, but what is undeniable, it that having this unique tax advantage is a powerful tool real estate investors can incorporate into their overall tax strategies.
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Interpreting Your Loses: A Quick Guide for K1s
In a syndication, losses, such as depreciation deductions, are shared among investors in proportion to their investment. Each investor's share of the income and deductions is reported on a K-1 form, which is crucial for understanding your tax obligations and planning your investment strategy. Given that, here is a quick reference guide from Precision Business Strategies to help you understand your previous K1s, and determine what steps you’d like to take now to see a K1 next year that aligns with your overall tax strategy:
Key Sections of Your K-1:
Entity Information:
This section provides details about the partnership, including its name, Employer Identification Number (EIN), and your percentage of ownership in the investment.
Income and Losses:
Look for Box 2 - Net Rental Real Estate Income (Loss). This represents your share of the partnership's income or losses from its real estate activities.
Look for Box 5 - Interest Income. This represents your share of the partnership's interest income earnings.
Distributions:
Look for Box 19 - Distributions. This represents the total amount of cash that was disbursed to you throughout the year.
Capital Account:
The Capital Account section (usually towards the end of the K-1) reflects your share of the partnership's equity. It tracks your initial investment, your share of profits, and any withdrawals or contributions you've made during the year. It's essential for understanding your ownership stake in the partnership.
Other Deductions:
Box 13 - Other Deductions may include expenses allocated to you, such as or mortgage interest.
· Other Information:
Check Box 20 - Code Z for additional information or special allocations.
Understanding the Capital Account
The Capital Account reflects your economic interest in the partnership. It's similar to a personal bank account within the partnership, tracking your contributions and share of profits or losses.
Changes to your Capital Account may occur due to various partnership activities, such as income, expenses, distributions, or contributions.
Why Act Now?
As 2023 comes to an end, this represents a pivotal opportunity for maximizing your tax savings through bonus depreciation. With the rate dropping next year, taking action now can significantly lower your taxable income for this year. Whether you join us in our Blue Lake Multifamily Fund, or identify other investments, not leaving “money on the table” is a year-end tax strategy to consider.
Key Takeaways:
Stay Informed About Tax Laws: Keep up-to-date with real estate investment tax changes.
Understand Your K-1 Form: Ensure you comprehend the tax implications outlined in your K-1 form.
Utilize Current Tax Benefits: Make the most of the current 80% bonus depreciation rate before it reduces.
Consult with Your Tax Advisor: Discuss with your tax advisor how the change in bonus depreciation rates will affect you and plan accordingly.
Final Thoughts
The transition into 2024 brings notable changes in tax benefits for real estate investors. Understanding your K-1 form and leveraging it for informed investment decisions is crucial. Now is the time to consult with your tax advisor to capitalize on the current favorable tax treatment and prepare for future investment strategies. This proactive approach is key to maintaining profitable investments in the changing tax landscape.
As always, Be Bold, Be great, and Keep Pushing Forward!
P.S. If one of your priorities, like mine, is building and preserving your wealth through multifamily real estate investments, click here to discuss how we can partner together.
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*The content provided on this website, including all downloadable resources, is for informational purposes only and should not be interpreted as financial advice. Furthermore, this material does not constitute an offer to sell or a solicitation of an offer to buy any securities.
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About Ellie Perlman
Ellie Perlman is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the founding host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.