Multifamily investors frequently misunderstand the relationship between K-1 losses and their bank account balances, leading to missed tax-saving opportunities and potential compliance missteps, according to Steven Libman, founder of Investing With Purpose™.
When investors receive their first K-1 partnership tax return showing a loss while their bank account shows distributions, many assume an error. Libman, who encounters this confusion regularly, explains that this disconnect stems from a deep-rooted association between the word “loss” and financial harm. In real estate, a K-1 loss typically signals the opposite: a non-cash expense that can shelter real income.
The mechanics begin with depreciation. The tax code allows property owners to deduct the wear and tear of a building over time, even though no check is written for it. For residential real estate, the standard depreciation schedule spans 27.5 years. A cost segregation study, an engineering report that breaks the property into components, can identify elements qualifying for shorter schedules 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.
This results in a property generating positive cash flow while simultaneously producing a tax loss large enough to shelter 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 connects the property’s depreciation to the individual investor’s tax return, flowing losses and deductions directly into the investor’s personal return.
One of the most overlooked 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 disappear. 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 who build a portfolio to accumulate a growing pool of losses that shelter income for years.
However, the ability to use these losses depends heavily on an individual’s tax situation. The IRS distinguishes between passive and active income, and most real estate losses are classified as passive, meaning they can only offset other passive income, not W-2 employment income. For those with W-2 jobs, this creates a limitation. But the real estate professional designation can change this. A taxpayer who spends at least 750 hours annually in real estate activities may qualify for treatment that allows 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 depreciation that flows through to K-1s. The firm treats tax losses as a benefit on top of the property’s standalone investment case, not as a substitute. “We underwrite the property as a standalone, and then the tax benefit is kind of the cherry on top,” Libman says. He notes that depreciation does not eliminate the tax obligation 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 investors treating K-1 documents as paperwork rather than strategy, understanding these mechanics is a baseline requirement of managing capital responsibly. Misreading these forms can lead to undervaluing tax benefits, applying rules incorrectly, and creating compliance exposure. More information on the firm’s investment approach is available at Investing With Purpose's investment page.
