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How can Multifamily Investors Pay Little or No Taxes on Their Profits

Updated: Mar 2, 2023

Every real estate investor wants to make money on his or her investments, and multifamily property investors are no exception. After all, why would anyone invest money in a real estate deal if profits were not the motivating factor?

It seems that everyone who makes profits on investments, whether the profits are from stock sales, commercial real estate or any other investment pays taxes. But thanks to the IRS, investors in multifamily property are able pay little to no taxes on their profits.

Let’s Take A Closer Look at Profits

Investors in multifamily properties receive two types of profits during the “hold period,” which is the time between the point when the property is purchased and the time when it is ultimately sold. They earn profits from income from the property, which includes rents, fees, etc., and profits from appreciation when the property sells. Remember, however that it us usually an LLC that owns the multifamily property, and investors purchase shares in the LLC. The profits are then distributed to the investors. Investors are able to use “pass-through taxation”, meaning 100% of expenses and profits go to the investors. At tax time, this is a great benefit.

Property income includes income from rents, fees and other monies generated by the property. Examples of fees might include premium or covered parking spaces, pet fees, in-unit washers and dryers, storage locker fees, premium Wi-Fi and other amenities.

The best way to increase rents and fees, and in turn income, is to purchase a value-add property, one that requires some repairs and renovation. By repairing and upgrading the exterior and renovating the apartments, you can begin to increase rents and charge additional fees for the new services and amenities you’ve installed.

Taxable Income from Proceeds from Property Sale

The second type of profit comes when the property is sold at the end of the hold period. This profit can often be substantial, assuming that the appreciation has met the original investment objectives. The appreciation is split among the investors, including the lead investor, or syndicator.

While nobody can guarantee appreciation on a multifamily property, there are many indicators that these properties will continue to appreciate over time.

Here’s why: there are currently about 75 million Baby Boomers who will be retiring soon, and many plan on selling their homes and renting. Trends show that a good number of Millennials are not buying homes or postponing their purchase, and renting instead. Some experts predict that many multifamily properties will be converted into retirement communities in the coming years. Finally, the cost to build new multifamily buildings is very expensive, helping to increase the value of existing properties now.

Tax Reduction Tactic #1: Operating Expenses

So how do investors end up paying little to no taxes on this income? Investors are able to deduct income against their expenses, which can add up to a considerable sum of money. They would include ongoing expenses such as utilities, property insurance, property taxes, salaries, property management fees, etc - just about anything and everything that is spent to keep the property running smoothly. They’re known as operating expenses, or OpEx.

Tax Reduction Tactic #2: Capital Expenses (“Capex”)

in addition to operating expenses, which are ongoing expenses, there are some one-time expenses involved with managing and maintaining a property. These one-time expenses might include having to replace a worn-out roof, or install a new HVAC unit, for example. Those types of expenses can be quite large, so they’re considered Capital Expenditures (CapEx). Investors can deduct their capital expenditure against the property’s income, since the IRS recognizes these expenses as legitimate expenses that can lower your taxable income.

Tax Reduction Tactic #3: Depreciation

One of the keys to paying little to zero taxes on income from multifamily properties is depreciation. The IRS has decided that multifamily properties depreciate over 27.5 years (and the countdown starts every time an investor purchases a property). As a passive investor in a multifamily property, you actually own shares of the LLC that owns the property, so you will enjoy the same depreciation benefits that an owner enjoys.

The only thing the IRS won’t let you depreciate is the land that your multifamily property sits on. Even if the building collapses, the land will still be there to build on again. So let’s look at an example that will help you understand how depreciation helps: if you invested funds that covered 10% of a $10,000,000 property, your share of the property is $1M. If you take out the value of the land, which you can’t depreciate, your share is worth about $800K. (We’re using 20% figure for the value of the land).

Your depreciation amount each year would be $29K ($800K divided by 27.5 years). That’s the amount you’ll get to deduct from the property’s income. That’s a substantial write-off, which is why multifamily property owners pay little to zero taxes. However, it gets even better.

Cost Segregation

While the IRS says that residential real estate depreciates over a period of 27.5 years, not every single item in the building will depreciate at the same rate. As an example, carpeting, kitchen cabinets, fixtures and other items may depreciate over a period of 5, 7 or 15 years. However, how can you separate out various elements of a building in order to accelerate the depreciation?

It’s done through what is known as a cost segregation study, or “cost-seg”. It’s a tool that real estate investors and syndicators use to preserve capital and enjoy significant tax benefits. The cost segregation analysis reclassifies assets and takes accelerated depreciation on the various assets in the property.

What types of property can qualify for a cost segregation analysis? There are actually very few restrictions on the multifamily properties that can qualify for a cost seg study. The property must have been placed in service after December 31, 1986. While any size property will qualify, lower valued properties are not good candidates for doing a cost segregation study. Economically, the study makes sense for properties that have a depreciable cost basis of $1 million and more.

There are three main benefits to investors of using a cost segregation study. First, it will generate an immediate cash flow increase by using accelerated depreciation tax deductions. Second, it dissects the property’s major components and improvements so you can write them off as they are replaced or renovated. Finally, it provides an independent third-party analysis that can hold up to IRS scrutiny.

The main benefit of course is that a cost segregation analysis will help owners and investors shelter substantially more taxable income - thanks to the accelerated depreciation deductions. That means an instant reduction in the amount of income taxes that will have to be paid in the current tax year. As a result, you’ll enjoy an immediate increase in cash flow from the real estate property.

Tax Reduction Tactic #4: 1031 Exchange

Most investors don’t have to pay taxes on appreciation until the property actually sells. However, just as the IRS came in to help investors with accelerated depreciation, they also can help investors when the property finally sells - through what is known as a 1031 Exchange.

The 1031 Exchange is a perfectly legal strategy used by many investors to avoid paying taxes when they sell a property. It allows investors to sell a property and use the profits to purchase a new, higher priced property. Instead of paying a long-term capital gains tax on the profit earned from appreciation, an investor can take those funds and use it as a downpayment on a new property.

According to the 1031 Exchange rule, the new property you exchange must be “like kind asset”. What does it mean? It simply means that the new property must be used for business or as an investment as well, so you can’t do a 1031 exchange from an investment to a primary residences.

In order to successfully defer your taxes using a 1031 Exchange, you need to identify the property you plan to purchase within 45 days of the sale of your first property. You can identify three possible options, but you must submit them within 45 days.

then, you have to close on the new property within 180 days. While six months may seem like a lot of time, it really isn’t in the world of commercial real estate. It forces investors to move faster with regard to doing whatever is necessary for closing on the property.


When you take into consideration all of the tax benefits enjoyed by investors in multifamily properties, it makes good sense to consider this type of investment. After all, there aren’t many investments where you pay little to no taxes on profits.

Property income is where the major ongoing profits come from, so it pays to generate as much income as possible. Expenses, both ongoing and Capital Expenditures, can be used to offset the profits. Plus, thanks to the ability to accelerate depreciation using a cost segregation study, you will be able to minimize your tax liability. Also, when the property sells, you can shelter your profits by reinvesting them using a 1031 Exchange. Taking everything into consideration, multifamily properties are an excellent investment to consider.

Are you a real estate investor and interested in learning more about passively investing in multifamily properties? Click here for the “Ultimate guide for the Passive Investor.”

Want to Invest with Ellie?

If you are interested in learning more about passively investing in apartment buildings, click here to schedule a call with Ellie Perlman.

About the Author

Ellie is the founder of Blue Lake Capital, a real estate company specializes is multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.

Ellie is the host of Unbelievable Real Estate Stories, a podcast that shares true stories from within the industry, and the critical lessons learned, from the most successful real estate investors, innovators, developers, and more from around the globe!

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 at and learn more about Ellie at


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