Tax Plays for Multifamily Investors: 1031 Exchanges, Cost Seg & Bonus Depreciation

Fresh capital pours into apartment buildings every cycle, yet almost every syndicator reaches a moment when attractive net‐operating income is dampened by federal and state levies. U.S. tax law offers three remarkably effective pressure-release valves: the like-kind exchange under §1031, engineering-driven cost-segregation studies, and first-year bonus depreciation.

Each method can stand alone, though the real magic appears when they are combined in a deliberately sequenced plan. New entrants - whether coming from single-family flips, medical practices, or tech paychecks, often know only the headlines. The pages that follow provide a deeper look, but in plain speech and with just enough arithmetic to see why seasoned operators guard these strategies like prized off-market leads.

How the IRS Sees an Apartment

Before tackling the marquee incentives, remember that the Internal Revenue Code classifies multifamily property as 27.5-year residential real estate. Land never depreciates, so its value must be carved out first.

A licensed appraiser, or a cost-seg specialist, typically allocates values in one of three ways:

Component	Recovery period	Typical share of purchase price
Building structure	27.5 years	70-80%
Site improvements (parking lots, fencing, landscaping)	15 years	5-10%
Personal property (appliances, carpet, fixtures)	5-7 years	10-15%

Each faster-lived bucket feeds bonus depreciation and cost-seg analysis. Leave those buckets unidentified and only straight-line deductions remain hardly the most efficient approach for anyone targeting double-digit internal rates of return.

1031 Like-Kind Exchange: Deferring, Not Dodging

A like-kind exchange lets an investor defer recognition of gain when relinquishing one investment property and acquiring another of equal or greater value. The rule survived multiple rounds of political debate during the 2020s; the July 2025 tax package left the real-estate portion intact.

In practice, a smooth swap hinges on four clock-based checkpoints:

• Day 0: Sign the purchase-and-sale agreement for the relinquished asset and engage a Qualified Intermediary (QI). The QI must receive sale proceeds; touching the cash even for a moment counts as constructive receipt and collapses the deferral.

• Day 45: Deliver a written list of potential replacement assets to the QI. Up to three properties may be listed without regard to dollar limits, or any number of properties if the total fair market value stays within 200% of the surrendered asset’s price.

• Day 180: Close on one or more chosen replacements. The latter of 180 days or the due date of that tax return (with extensions) governs the deadline.

• Equal or higher equity and debt: Match or exceed the amount of equity and debt that existed on the relinquished asset. Shortfalls may be offset with fresh cash, yet excess boot becomes taxable.

Mini-Case

Imagine selling a 30-unit garden complex for $5 million with $2 million in debt. Purchase a 40-unit asset for $6 million, finance it with $2.5 million in debt, and the deferral remains fully intact. Drop the new debt to $1.5 million and the $500 k shortfall triggers current income tax.

Common missteps

1. Missing the identification window by treating “verbal notices” as valid.

2. Listing four properties above the 200% threshold while planning to buy only one.

3. Forgetting state conformity - California, for instance, still taxes boot even when the federal return shows none.

Cost-Segregation: Engineering Your Write-Offs

Cost segregation is a forensic construction study that parses a building into digestible slices on day one rather than waiting almost three decades. By reclassifying site improvements and personal property into 5, 7, and 15-year lives, an owner increases Year 1 deductions even without bonus depreciation. The math is simple: bring future write-offs into the present, then reinvest the tax savings in value-add projects or new acquisitions.

A high-level division for a 1970s vintage, 100-unit property:

Asset class	Percentage of total basis	Accelerated recovery method
Carpeting & vinyl plank	4%	5-year, double-declining balance
Appliances & HVAC	6%	7-year, double-declining balance
Asphalt drives, curbs, exterior lighting	8%	15-year, 150% declining balance

That 18% slice often finds its way into bonus depreciation, amplifying the impact further still. Out-of-pocket cost for the study typically ranges between $6k and $15k on midsize deals, an investment many sponsors bake into acquisition budgets from day one.

Bonus Depreciation: A Moving Target Now Locked at 100% - Again

The Tax Cuts and Jobs Act granted a 100% first-year deduction for eligible property placed in service late 2017 through 2022, then stated that the percentage would fall 20 points each year. Market participants braced for a 40% cap in 2025. Then the One Big Beautiful Bill (OBBBA) signed July 4, 2025 reversed the slide, returning the allowance to a full write-off for property placed in service after that date Plante Moran. Assets placed in service between January 1 and July 3 still follow the phase-down.

Year placed in service	Bonus % under TCJA	Bonus % under OBBBA*
2023	80%	80%
2024	60%	60%
2025 (1/1 – 7/3)	40%	40%
2025 (7/4 – 12/31)	40%	100%
2026	20%	100%
2027+	0%	100%

Practical impact

A syndicate closing a $10 million acquisition on August 15, 2025 might allocate $1.8 million to five- and seven-year property plus $800 k to site improvements. With OBBBA, the entire $2.6 million may be deducted in Year 1, creating a paper loss that often shields cash distributions for limited partners who meet passive-activity thresholds.

Putting the three plays together

A coordinated plan can reset depreciation every few years and still sidestep immediate gain recognition:

1. Acquire an asset with fresh equity or via a §1031 exchange.

2. Order a cost-segregation study and claim first-year bonus depreciation.

3. Stabilize, refinance, distribute. Cash-out proceeds remain tax neutral to the extent the loan is non-recourse and total loan-to-value stays within safe-harbor limits.

4. Dispose of the property after value creation peaks, rolling gain into the next deal under §1031.

5. Repeat.

Stack example

• Equity raised: $3 million

• Cost-seg write-off: $2.4 million

• Investor share of deduction (90% to LPs): $2.16 million

• LP cash flow in Year 1:8% preferred return → $240 k

• Net taxable income reported: roughly zero for most passive investors holding units personally. Schedule K-1 often shows a loss carried forward to shelter future distributions.

Small partnerships that self-manage may meet the real-estate-professional standard, turning passive losses into active ones - a nuance to explore with personal advisors, yet a life-changing shift for many who leave W-2 positions to go full-time.

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Financing realities in 2025

Cap-rate expansion from 2022 through 2024 pushed many owners to extend holding periods. The OBBBA surprise restored an incentive to place assets in service inside the calendar year. Bridge lenders report pipelines filling with acquisitions scheduled to close during Q3 and Q4, paired with five-year caps obtained via third-party rate-cap providers. In metro areas where nominal rents stagnated, the incremental cash from accelerated deductions can tip returns back above the twelve-percent IRR mark even when loan coupons sit near six.

Debt service coverage tests still matter. Lenders do not underwrite tax benefits, so projects must carry themselves on true NOI. Yet the extra cash staying in investor pockets often funds unit upgrades, which, in turn, raise rents and restart the virtuous cycle.

Passive-loss rules, state quirks, and exit math

Federal passive-activity limits cap the ability to offset W-2 income unless hours-worked and material-participation thresholds are cleared. Married couples who jointly hit 750 hours per year across real-estate trades can apply those deductions directly against salaries or consulting fees. For everyone else, passive losses sit on Form 8582 until future passive income appears.

State conformity provides another wrinkle:

• Texas and Florida: Full alignment with federal treatment—no state income tax.

• Arizona: Mirrors federal bonus rules yet caps §179 expensing.

• California: Disallows bonus depreciation, adds it back in year one, and then grants straight-line deductions over the federal life.

Plan cash reserves for potential state liabilities, especially in year one when federal taxable income shows a loss, yet state income may appear positive.

Checklist for new sponsors

• Engage a QI before signing closing docs for a sale.

• Collect closing statements, engineering drawings, and big-ticket invoices; cost-seg firms rely on them.

• Model two timelines for 2025 closings - one before and one after July 4, to capture the pivot point in bonus percentages.

• Review partnership agreements; distribution waterfalls sometimes require amendments to reflect timing of tax losses.

• Book a pre-construction walk with the cost-seg team to identify assets that will be removed during renovations; partial disposition can trigger additional deductions.

• Track the 5- and 15-year buckets separately inside the chart of accounts so that mid-stream dispositions are easy to report.

Policy watch

Washington chatter hints at an annual review clause tied to fiscal-deficit targets. Even with permanent status in statutory text, bonus depreciation could be trimmed for assets placed in service after 2030. The real-estate lobby fought for grandfather protection; still, sponsors closing in late cycles should watch committee markups.

Possible §1031 caps resurface every budget cycle as well. The latest White House draft floated a $4 million annual exclusion yet stalled in committee. The strategy: keep roots in states with delegation seats on the tax-writing committees, follow hearings, and stay nimble.

Multifamily success is rarely about finding silver bullets. Cash flow comes from operational discipline, tenant retention, and prudent leverage. Tax plays multiply those efforts. When §1031 shielding is combined with a laser-scalpel cost-seg study and first-year bonus deductions, the after-tax yield often leaps far beyond what cap-rate spreads alone imply. Start small if needed, refine the process, and graduate to larger assets once the ecosystem - attorneys, CPAs, engineers, lenders, moves in lockstep.

This article offers an educational overview, not individualized advice. Bring your own CPA and securities counsel to every closing table. Very few moves in real estate are fully reversible. Get them right the first time and the balance sheet grows faster than most new investors imagine.

Credit: (Dominion Financial Services, Thomson Reuters, IRS, The Tax Adviser, CSA Partners)

No Offer or Solicitation

This communication is intended solely for informational and educational purposes. It does not constitute, and shall not be construed as, an offer, invitation, or solicitation to purchase, acquire, subscribe for, sell, or otherwise dispose of any real estate investments, securities, or related financial instruments. Nothing contained herein should be interpreted as a recommendation or endorsement of any specific investment strategy or opportunity. Furthermore, this communication does not represent, and shall not be deemed to constitute, the issuance, sale, or transfer of any real estate interests in any jurisdiction where such actions would be in violation of applicable laws, regulations, or licensing requirements.

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