K-1 Losses Confuse Multifamily Investors, But They Signal Cash Profits

When multifamily investors receive their first K-1 partnership tax return, many assume an error occurred. The document shows a loss, yet their bank account shows distributions. This apparent contradiction confuses investors and, according to Steven Libman, founder of Investing With Purpose™, leads them to misunderstand a key benefit of multifamily investing.

Libman notes that the disconnect between paper losses and real cash stems from a common association of the word “loss” with financial harm. In real estate, however, 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. A cost segregation study can identify components that qualify for shorter schedules of five, seven, or 15 years, and under 100% bonus depreciation, those can be deducted entirely in year one.

The result is that a property can generate real positive cash flow while 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 investor’s personal tax return, delivering the losses generated by the cost segregation study.

Investors often leave value behind by misunderstanding what happens to losses they cannot use immediately. They assume unused losses expire, but Libman clarifies they do not. If an investor generates $150,000 in K-1 losses but only has $100,000 in taxable income to offset, the remaining $50,000 carries forward indefinitely. This makes depreciation a long-term tax asset. “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.”

An investor who builds a portfolio of multifamily assets can accumulate carried-forward losses that shelter income for years. Libman describes this as a compounding effect on capital that would otherwise be paid in taxes and is instead reinvested. “It’s partly deferral. It’s not a magic eraser,” he says, “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.”

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 employment income. However, the IRS real estate professional designation can change this. A taxpayer who spends at least 750 hours annually in real estate activities may qualify to offset other income, including W-2 income when married and filing jointly. “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,” Libman says.

Investors who don't understand these rules may underestimate the value of their K-1 losses or apply them incorrectly, creating compliance exposure. At Investing With Purpose, Libman says the firm runs cost segregation studies as a standard part of the acquisition process. 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,” he notes. Depreciation does not eliminate taxes permanently; there is recapture upon sale, but buying a new property in the same year generates fresh depreciation, creating a stacked benefit. For those treating K-1 documents as paperwork rather than strategy, understanding these mechanics is essential for managing capital responsibly. More information is available at https://iwpurpose.com/invest/index.html.