When multifamily investors receive their first K-1 partnership tax return, many are alarmed to see a loss while their bank account shows healthy distributions. This apparent contradiction, according to Steven Libman, founder of Investing With Purpose™, stems from a fundamental misunderstanding of how real estate tax losses work. Libman emphasizes that in real estate, a K-1 loss often signals the opposite of financial harm, and misreading it can cost investors significant tax advantages.
The root of this confusion lies in depreciation. The tax code allows property owners to deduct the wear and tear of a building over time, even though no cash is spent on that wear and tear. For residential real estate, the standard depreciation schedule spreads this deduction over 27.5 years. However, a cost segregation study—an engineering report that breaks the property into its components—can identify elements that qualify for shorter depreciation periods of five, seven, or 15 years. Under 100% bonus depreciation, anything on a 15-year or shorter schedule can be pulled entirely into year one. The result is that a property can generate real positive cash flow while simultaneously producing 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, delivering the losses generated by the cost segregation study.
One of the most overlooked features is the carry-forward capability of unused losses. Libman points out that if an investor generates $150,000 in K-1 losses but only has $100,000 in taxable income, the remaining $50,000 does not expire. Instead, it carries forward indefinitely, available 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 turns depreciation into a long-term tax asset, allowing investors to build a growing pool of carried-forward losses that shelter income for years.
However, the ability to use these losses depends on an individual’s tax situation, particularly the IRS rules on passive activity. Most real estate losses are classified as passive, meaning they can only offset other passive income, not W-2 employment income. For those with a W-2 job, this creates a limitation. But Libman highlights a strategy that can change this: the real estate professional designation. A taxpayer who spends at least 750 hours annually in real estate activities may qualify for treatment that allows those losses 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,” Libman says.
At Investing With Purpose, Libman says the firm runs cost segregation studies as a standard part of the acquisition process, generating the depreciation that flows through to K-1s. The firm treats the resulting 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.” Libman also notes that depreciation does not eliminate the tax obligation permanently—there is recapture when the 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 investors treating K-1 documents as mere paperwork, Libman says understanding these mechanics is a baseline requirement of managing capital responsibly. Misreading K-1 losses can lead to missed opportunities and compliance exposure. As Libman advises, “It’s partly deferral. It’s not a magic eraser, but if you’re not paying taxes and it gets to compound while you’re utilizing that depreciation, you can see your net worth climb much faster.” For more information on the firm’s investment approach, visit https://iwpurpose.com/invest/index.html.
