For many real estate investors, the arrival of their first K-1 form can trigger confusion and concern. The document often shows a loss, yet their bank account reflects a distribution. This apparent contradiction is one of the most common points of confusion in multifamily investing, according to Steven Libman, founder of Investing With Purpose™. Libman explains that a K-1 loss in real estate typically signals the opposite of what the word 'loss' implies—it is often a sign of a non-cash expense that can shelter income and boost cash flow.
The mechanics begin with depreciation, a tax deduction for the wear and tear on a building over time. For residential real estate, the standard depreciation schedule spans 27.5 years. However, a cost segregation study, an engineering report that breaks down the property into components, can identify items with shorter recovery periods of five, seven, or 15 years. Under 100% bonus depreciation, these shorter-life assets can be fully deducted in the first year. This allows a property to generate real, positive cash flow while simultaneously producing a tax loss large enough to offset 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 form connects the property's depreciation to the individual investor's tax return, flowing through the partnership's income, losses, and deductions directly to the investor.
Investors often misunderstand what happens to losses they cannot use immediately. The assumption is that unused losses expire, but they do not. If an investor generates $150,000 in K-1 losses but only has $100,000 in taxable income, the remaining $50,000 carries forward indefinitely. "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 carry-forward feature turns depreciation into a long-term tax asset. An investor who builds a portfolio of multifamily assets can accumulate a growing pool of carried-forward losses that shelters income for years. Libman describes this as a compounding effect on the capital that would otherwise be paid in taxes, allowing net worth to climb faster.
The ability to use K-1 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. However, the real estate professional designation can change this. A taxpayer who spends at least 750 hours annually in real estate activities may qualify to offset W-2 income if married and 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. "We underwrite the property as a standalone, and then the tax benefit is kind of the cherry on top," he says. "We never make it part of our underwriting assumptions." Depreciation does not eliminate taxes permanently; there is recapture upon sale. But those who purchase a new property in the same year they sell can generate fresh depreciation, creating a stacked tax benefit that continues the cycle.
Understanding these mechanics is essential for managing capital responsibly. Misreading K-1 losses can lead to missed opportunities or compliance issues. Investors should consult qualified professionals to maximize the benefits of depreciation and carry-forward losses.
