When multifamily investors receive their first K-1 partnership tax return, many are alarmed to see a loss while their bank account shows deposits. This confusion, according to Steven Libman, founder of Investing With Purpose™, leads investors to misread one of the most valuable features of multifamily investing: the tax benefits of depreciation.
Libman explains that the disconnect stems from a common association between the word “loss” and actual financial harm. In real estate, a K-1 loss typically signals the opposite. The mechanics begin with depreciation, which allows property owners to deduct the wear and tear of a building over time, even though no cash is spent. For residential real estate, the standard depreciation schedule spreads over 27.5 years. However, a cost segregation study can identify components that qualify for shorter schedules (5, 7, or 15 years), and under 100% bonus depreciation, those can be pulled entirely into year one. The result: a property can generate real, positive cash flow while 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 taxes.
Investors often leave value behind by misunderstanding what happens to losses they cannot immediately use. According to Libman, unused losses do not expire; they carry forward indefinitely. If an investor generates $150,000 in K-1 losses but only has $100,000 in taxable income, the remaining $50,000 carries forward to offset future income. “Those carry forward in perpetuity, so that can continue to offset income down the road, not just this year,” Libman says. “It’s not like if you don’t use it, you lose it. You get to keep it.” This feature turns depreciation into a long-term tax asset, and building a portfolio of multifamily assets can create a growing pool of carried-forward losses.
However, the ability to use K-1 losses depends on an individual’s tax situation. Most real estate losses are classified as passive, meaning they can only offset other passive income, not W-2 wages. For those with a W-2 job, this is a limitation. Libman points to the real estate professional designation, which requires spending at least 750 hours annually in real estate activities. If a taxpayer qualifies (and files jointly with a spouse who has W-2 income), those losses can offset W-2 income. “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, Libman says the firm runs cost segregation studies as a standard part of the acquisition process, generating depreciation that flows through to K-1s. The firm treats tax losses as a benefit on top of the property’s standalone investment case. “We underwrite the property as a standalone, and then the tax benefit is kind of the cherry on top,” Libman says. “We never make it part of our underwriting assumptions.”
Libman notes that depreciation does not eliminate taxes permanently; there is recapture when an asset is sold. But those who purchase a new property in the same year they sell generate fresh depreciation, creating a stacked tax benefit that continues the cycle. For those who treat K-1 documents as paperwork rather than strategy, understanding these mechanics is a baseline requirement for managing capital responsibly. More information on the firm’s investment approach is available at Investing With Purpose.
