Client Profile
| Industry | Multifamily Real Estate Investor |
| Property | 48-Unit Apartment Complex |
| Purchase Price | $4,800,000 |
| State | Alabama |
| Key Metric | REPS + Grouping Election |
| Year-One Tax Savings | $340,000 |
The Problem
This investor had recently acquired a 48-unit apartment complex for $4.8 million ($3.84 million allocated to the building). The investor's spouse managed the property full-time while the investor operated a separate business generating $900,000 in annual income. The prior accountant had placed the building on a standard 27.5-year MACRS schedule, producing annual depreciation of only $139,600.
More critically, the prior accountant had classified all rental income and losses as passive — the depreciation deductions were trapped. The accountant had not evaluated REPS under IRC §469(c)(7).
AE Tax Strategy
1. Cost Segregation Study Under IRC §168
We commissioned a detailed cost segregation study. The study reclassified $1,344,000 (35% of building basis) from 27.5-year property to shorter recovery periods: $576,000 to 5-year property, $230,000 to 7-year property, and $538,000 to 15-year property. First-year depreciation increased from $139,600 to approximately $945,000.
2. Real Estate Professional Status Under IRC §469(c)(7)
We documented that the investor's spouse spent over 1,800 hours per year managing the complex and two smaller rentals, exceeding the 750-hour threshold. With REPS status established, all rental losses became non-passive.
3. Grouping Election Under IRC §469
We filed a grouping election to treat all rental properties as a single activity, ensuring the massive accelerated depreciation could offset active business income.
Before & After Comparison
| Category | Before | After | Benefit |
|---|---|---|---|
| Year 1 Depreciation | $139,600 | $945,000 | +$805,400 |
| Loss Classification | Passive (suspended) | Non-Passive (usable) | Losses unlocked |
| Active Income Offset | $0 | $900,000 | $900,000 |
| Year-One Tax Savings | $0 | $340,000 | $340,000 |
Key Takeaways
- Multifamily properties have significant cost segregation potential due to unit-level components that qualify for 5-year recovery periods.
- Real Estate Professional Status through a qualifying spouse allows rental losses to be treated as non-passive on a joint return.
- A grouping election consolidates multiple properties into a single activity for material participation and loss aggregation.
- The combination of cost segregation and REPS status is one of the most powerful legal tax reduction strategies available to real estate investors.