For many multifamily real estate investors, the first K-1 partnership tax return can be a source of confusion. The document shows a loss, yet the bank account shows distributions. This apparent contradiction, according to Steven Libman, founder of Investing With Purpose™, leads investors to misunderstand one of the most valuable features of multifamily investing: the tax benefits that come with depreciation.
The disconnect stems from a common association between the word “loss” and 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 actually spent on that wear and tear. For residential real estate, the standard depreciation schedule spreads the deduction over 27.5 years. A cost segregation study can identify components that qualify for shorter schedules—five, seven, or 15 years—and under 100% bonus depreciation, anything on a 15-year or shorter schedule can be pulled into year one.
This means a property can produce real, positive cash flow while simultaneously generating a tax loss large enough to shelter that income entirely. “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 connects the property’s depreciation to the individual investor’s tax return, flowing deductions directly into the investor’s personal return.
One of the most underutilized features is the carry-forward of unused losses. If an investor generates $150,000 in K-1 losses but only has $100,000 in taxable income to offset, the remaining $50,000 does not expire. “Those carry forward in perpetuity, so that can continue to offset income down the road, not just this year,” Libman explains. “It’s not like if you don’t use it, you lose it. You get to keep it.” This turns depreciation into a long-term tax asset, and for investors building a portfolio, accumulated losses can shelter income far into the future.
However, the ability to use K-1 losses depends heavily on an individual’s tax situation. Most real estate losses are classified as passive, meaning they can typically offset only other passive income, not W-2 employment income. For those with a regular job, this creates a limitation. But Libman points to the real estate professional designation, which allows taxpayers who spend at least 750 hours annually in real estate activities to offset other income, including W-2 income when filing jointly with a qualifying spouse. “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,” he says. Misunderstanding these rules can lead to underestimating the value of losses or incorrectly applying them, creating compliance risk.
At Investing With Purpose, cost segregation studies are standard in the acquisition process, generating depreciation that flows through to K-1s. The firm treats tax losses as a benefit layered on top of the property’s standalone investment case, not as a substitute for it. “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.”
While depreciation does not permanently eliminate tax—there is recapture upon sale—investors who buy a new property in the same year they sell can generate fresh depreciation, creating a stacked tax benefit that continues the cycle. For investors, understanding these mechanics is essential to managing capital responsibly. More information on the firm’s investment approach is available at Investing With Purpose.
