Tax Benefits on income of a 5+ unit property vs a 4 unit or less?

Question

I am a new investor and looking to buy my first property and scale out soon after. I was trying to understand if there is a difference in tax benefits for the rental income if the property is a 4 or less unit or a 5 or more unit property. I know that 5+ would make it commercial, but would that change how much taxes I would have to pay on the income from the property? If so how? Does it have to be purchased by an entity like and LLC or is it just silly not to? Are there any specific downfalls to going above 5+ unit properties as a new investor, or is it all the same just bigger numbers? Thanks in advance.

Account Closed · Answer

@Michael P. I think the period of time over which the IRS allows you to depreciate the property is slightly longer, but don't quote me on that. I don't know personally of any other significant differences.

I would say go straight to 5+ units if the numbers make sense. You should be able to operate it for a slightly lower expense ratio if it's apples to apples as far as quality goes to any smaller buildings you're considering.

John L. · Answer

@Michael P. It sounds like the loan you're referencing for commercial properties (30-year amortization) relies on agency debt, where the loan balance would likely need to be over $1M.

I would call some local lenders and see what they would recommend for 5 or so units. If you have a sample property they'll be able to advise more specifically.

Matt Devincenzo · Answer

The depreciation for both is the same...for taxes both are 'residential' ....the residential/commercial adjective does not mean the same thing in all cases. For taxes it's a use charactaristic, for loans it's a lender's threshold...

Back to your basic question, for taxes there is no difference between them. What works for a SFR rental will work for an apartment. It's the economies of scale that change whether a specific strategy is financially worth while or not.

Michael P. · Answer

I've been noticing that the loan terms of commercial properties (5+ unit and up) have a term of much less than the traditional 30 yr for single families. It may be amortized over 15 to 30 yrs but it seems  like the principle is due within the first 5 to 10 yrs. Looks like its very hard to find a 30 yr commercial loan. My question is, do the same rules apply to 2 to 4 unit properties that are not considered commercial? Can you find a 30 yr fixed rate loan any easier for this or is it just as hard as  5+ unit?

Jaysen Medhurst · Answer

@Michael P., the loans for 1-4 are better because the rates are lower, the amortization can be longer, and the term/amortization are the same.

My understanding is that most commercial lenders want a property to be held in a LLC, corp. etc., not a personal name. Perhaps that has something to do with the fact that the loans are usually non-recourse, I'm not sure.

Taxes are the same, as long as you're comparing apples to apples. Always talk to your CPA!

Depreciation is longer with a commercial property, 39 years vs. 27.5. Another thing to consider is doing a segregation study to front load that depreciation. The extra cost may not make sense for a duplex, but for a 15-unit apartment complex the number may look good.

Not sure what you mean by "...looking for conventional or FHA and trying to say it is your residence?" Falsely claiming you are an owner-occupant is mortgage fraud and not something to be trifled with. Don't do this.

Michael P. · Answer

Bill,

Thanks for the response. Are the loans still better if you are buying the 1-4 unit property in an LLC? Or only if you put it in your individual name and are looking for conventional or FHA and trying to say it is your residence? How are the loans better? Rates points? in what respect? Taxes are the same? Depreciation? Corporation taxes vs Individual? Thanks again

Bill B. · Answer

The taxes are the same.

You don’t need an llc.

The big difference is much better loans available for 1-4 units.