As a residential property investor, it’s important to take advantage of tax benefits when possible to ensure you’re boosting your bottom line. Paying taxes is a must and can be quite costly, which is why there are many tricks to minimize the obligations surrounding multi-family home taxes.
Let’s explore the different ways that real estate investors can make reductions to the amount of property taxes owed on their multi-family homes.
Real Estate Depreciation Tax
Real estate depreciation is based on the principle that a rental property’s value declines over time due to wear and tear on the home. Think about it like a car’s value. As soon as the car comes off the lot, the quality and value begin to diminish. However, the home’s value is not usually decreasing because of factors like maintenance, renovations, neighborhood popularity, and market demand — which is why real estate depreciation is often referred to as a “phantom” expense for investors.
Because of real estate depreciation, the IRS allows investors to take a tax deduction based on the estimated decrease in the value of the multi-family property. This means that the investors can actually have a positive cash flow from the multi-family property, but shows a tax loss on paper — offering investors a major tax break.
How to Calculate Real Estate Depreciation
The IRS believes that a residential property is only useful for 27.5 years. This means that investors are able to deduct a depreciation expense from their taxes. Calculating your multi-family property’s depreciation amount is relatively simple and requires you to divide the property’s value by 27.5.
As an example, let’s look at a multi-family property worth $750,000. When dividing it’s value by 27.5, you will calculate a depreciation expense of $27,272.
Factoring that depreciation expense into your taxable income illustrates just how much an investor will save. Consider that your multi-family property generates $100,000 per year. This means you would have the following tax obligations:
Taxes owed without depreciation = $100,000 x 25% (federal income tax) = $25,000
Taxes owed with depreciation = ($100,000 – $27,272) x 25% = $18,182
With no other deductions other than a real estate depreciation tax, investors in this scenario would save $6,818 annually — which is massive tax savings of property taxes for multi-family homes!
Similar to real estate depreciation, there is another tax benefit known as cost-segregation which also factors in the depreciation of elements within the multi-family property. This includes elements such as appliances, fixtures, and cabinets.
Unlike the home itself, these items within the home have a much shorter lifespan which can be written off taxes for no more than seven years.
One important thing to note when considering cost-segregation is that the more you use this on your annual taxes, the higher your tax bill will be upon selling the property. If you plan to sell the property and want to reduce taxes during the sale, be mindful of this tax benefit for multi-family homes in Utah.
As a residential real estate investor, you must take advantage of various tax deductions. In layman’s terms, a tax deduction is any type of expense that can be written off of your taxable income. With your multi-family home taxes, you have the ability to deduct any expenses incurred while managing, maintaining, or repairing your property from the total taxable rental income.
Consider writing off the following expenses you might incur with your multi-family property:
- Property management costs
- Maintenance or repair fees
- Monthly utilities (water, gas, electric, etc.)
- Property marketing costs
- Mortgage interest
- And more!
Investors of multi-family properties can really benefit from tax deductions (as well as depreciation and cost-segregation) in comparison to single-family investments. When filing property taxes for multi-family homes, you can pay a single tax bill that covers all the units within the property — making it more efficient to file and likely offers a higher rate than that of a single-family home.
The AA Tax & Accounting Services team is committed to maximizing our clients’ tax savings. Our full-service accounting firm has spent years serving Cedar City, Utah, and surrounding Southern Utah towns providing effective tax strategies for multi-family investors. Contact us to schedule an appointment.