For many multifamily real estate investors, the first K-1 partnership tax return can be a jarring experience. The document shows a loss, yet their bank account shows healthy distributions. This apparent contradiction, says Steven Libman, founder of Investing With Purpose™, leads many to misread one of the most valuable features of multifamily investing.
Libman, who has spent years guiding investors through the complexities of real estate tax strategy, explains that the disconnect between paper losses and actual cash flow is one of the most common points of confusion he encounters. It stems from a deeply ingrained association between the word “loss” and financial harm. In real estate, however, a K-1 loss often 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 ever written for that wear and tear. For residential real estate, the standard depreciation schedule spreads that deduction over 27.5 years. A cost segregation study, an engineering report that breaks the property into its individual components, can identify which elements qualify for shorter depreciation 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.
The result, according to Libman, is that a property can generate real, positive cash flow—actual deposits into accounts—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 itself connects the property’s depreciation to the individual investor’s tax return. It is a partnership tax document that delivers a slice of the partnership’s income, losses, and deductions, flowing directly into the investor’s personal return. The cost segregation study generates the losses; the K-1 delivers them.
One of the most underutilized features of K-1 losses is their carry-forward capability. Many investors assume that unused losses expire, but Libman clarifies that they do not. If an investor generates $150,000 in K-1 losses in a given year but only has $100,000 in taxable income to offset, the remaining $50,000 does not disappear. It carries forward indefinitely, available to offset income in future years. This turns depreciation from a single-year benefit into 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 says. “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 over time can accumulate a growing pool of carried-forward losses that continues to shelter income long after the original depreciation was generated. Libman describes this as a compounding effect—not on the losses themselves, but on the capital that would otherwise have been 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.”
However, the ability to use K-1 losses depends heavily on an individual’s tax situation, and this is where many make costly assumptions. The IRS distinguishes between passive and active income, and most real estate losses are classified as passive, meaning they can typically only offset other passive income, not W-2 employment income. For those with a W-2 job, this creates a limitation. Libman points to one strategy that can change this picture: the real estate professional designation. Under IRS rules, a taxpayer who spends at least 750 hours annually in real estate activities—not necessarily as a licensed agent, but as an investor, operator, or short-term rental owner—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.
Those 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, 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 notes that depreciation does not eliminate the tax obligation permanently. There is recapture when an asset is sold; the IRS claims back a portion of the benefit. But those who purchase a new property in the same year they sell generate fresh depreciation, creating what Libman describes as a stacked tax benefit that continues the cycle. For those treating K-1 documents as paperwork rather than strategy, Libman says understanding these mechanics is a baseline requirement of managing capital responsibly. More information on the firm’s investment approach is available at Investing With Purpose.
