There are many tax benefits for investors and owners in commercial real estate. Understanding all of them, however, can be a monumental task. David Goodnight will cover the top 10 most commonly used tax benefits in the industry, and how to take advantage of them.
1. Commercial Mortgage Interest is Tax Deductible
Just like homeowners, commercial real estate owners can deduct their commercial mortgage interest from their taxes. In some cases, this deduction is high enough to offset the taxes owed on profits generated by a property. This is especially true in the case of mortgages with higher interest rates.
To take advantage of this tax benefit, simply claim your accumulated mortgage interest payments at tax time. If, for example, you’ve paid $2,500 a month in interest all year long, you can claim a $30,000 tax deduction.
2. Depreciation is a Tax Benefit
Like all structures, commercial real estate properties go through wear and tear over time. Because of this, the IRS allows investors and owners to claim depreciation as a tax deduction over 39 years for commercial properties. Like mortgage interest, claiming depreciation can offset taxes owed on profits.
There are a few ways to leverage depreciation as a tax benefit. Besides the annual IRS permission, investors can hire an engineering firm to do a cost depreciation study for shorter periods of time. This allows for higher deductions in the short-term. There are also bonus depreciation deductions, which allow some investors to benefit even faster. Occasionally, investors can even take 100% of property value as a deduction.
3. Tax Deductible Non-Mortgage Expenses
Maintaining a commercial property takes a lot of work, and work costs money. A number of expenses associated with this upkeep are deductible. These expenses can include:
- repairs
- maintenance
- management expenses
- renovations
- upgrades
- condo fees
Keep in mind, not all of these expenses are eligible for everyone. In the case of condo fees, for example, an investor must live on the property or use it for work. Management expenses are also limited to a select few. Tax benefits from renovations are only gained as the improvements depreciate.
With the right advisement, investors can also deduct operational expenses such as travel to and from a property, hotel expenses, and part of food and beverage costs. Real estate seminars, conferences, conventions, and other educational events are also all potential deductions.
4. Lower Capital Gains Tax Rate
For those planning for retirement, commercial real estate investment has some tax benefits over a traditional IRA. One of these benefits in particular is the lower capital gains tax rate. IRA gains are taxed at a personal rate when withdrawn. By contrast, the capital gains from the sale of a commercial property are usually taxed at a lower rate.
To take advantage of this tax benefit, invest in commercial real estate early to maximize gains at the time of retirement. This is also a great approach for business owners looking for security in assets in the case of business closure.
5. Minimize Tax for Beneficiaries
If the plan for a commercial property is to pass it on to beneficiaries, investors can rest easy knowing that they won’t be burdening the recipients with a large tax bill. Heirs of a commercial property who decide to sell only pay tax on the increased value from the time of inheritance.
To maximize this inheritance, invest early and wisely, and be sure to create a will or living trust.
6. Qualified Business Income Tax Deduction
One of the most exciting things for commercial real estate investors about the Tax Cuts and Jobs Act is Sec 199A. Sec 199A covers the qualified business income (QBI) deduction, a tax deduction of 20% of qualifying income, plus 20% of qualified real estate investment trust (REIT) dividends.
Importantly, income generated by the sale of property and treated as capital gains is not considered qualifying income. Income generated from rental properties, however, do qualify for this tax deduction thanks to safe harbor.
7. Section 1031 Defers Tax
Section 1031 is another IRS code with tax benefits for commercial real estate investors. Also known as a like-kind exchange, it allows investors to swap properties without recognizing a taxable capital gain. This greatly limits the taxes which would be required of a typical sale.
To take advantage of Section 1031, a new commercial property must be of equal or greater value to the initial one. Investors also cannot live in the property they are swapping. To maximize tax benefits, plan to swap often over time rather than buying new commercial real estate. There is no limit on how many times an investor can use Section 1031, so taxes don’t need to be paid until a property is sold rather than swapped.
8. Opportunity Zones Have Many Tax Benefits
Opportunity Zones offer multiple tax benefits, including deferral of capital gains tax and both step-up and complete tax exclusions.
9. Federal Tax Credits
The U.S. federal government provides a number of tax credit programs which benefit commercial real estate investors. These programs include:
- Low-Income Housing Tax Credit (LIHTC)
- Historic Tax Credit (HTC)
- New Markets Tax Credit (NMTC)
10. Tax Advantages for Commercial Real Estate Losses
While no one wants to think about taking a loss on property, it’s reassuring to know that there are safety nets in place for commercial real estate investors. Many losses incurred through commercial properties can be claimed as deductions, depending on an investor’s income and whether they work in the industry.