5 MAJOR TAX BENEFITS IN COMMERCIAL REAL ESTATE OWNERSHIP

Real estate continues to be one of the most popular investment strategies for protecting and growing one’s wealth. Combined with the enticement of generating cash flow, investing in real estate also opens a treasure chest of tax advantages that renting does not.  Investing in rental property also provides numerous tax benefits compared to many other income-producing assets. Below are 5 major benefits of commercial real estate ownership:

• Depreciation
• 1031 Exchanges for Tax Deferral
• Deductible Non-Mortgage Expenses
• Minimized Tax for Beneficiaries
• Opportunity Zones

 

1. Depreciation

In commercial real estate, structures and other assets on properties usually don’t last forever. They experience wear and tear, and therefore, their value depreciates over time. Commercial real estate properties have a depreciation period of 39 years, as set by the IRS. This means that a commercial real estate owner can deduct the cost of a property over 39 years. In the simplest example, if a building on a property is worth $390,000, an owner can take a tax deduction of $10,000 every full year for 39 years and a prorated amount for a partial year.

These depreciations are used to offset the taxes that are owed on the profits made from the property. And to be clear, land does not depreciate; only the buildings or structures on that land do. This deduction will lower the yearly taxable income of a CRE property, and it can even get to a point where the property will show a zero-taxable income and still be producing a profit!

Another benefit of depreciation applies to different parts of a property that depreciate at various rates. An owner can hire an engineering firm to conduct a cost segregation study on individual components of a property, such as a roof. If the life expectancy of the roof is 15 years, the value of the roof can be depreciated on a 15-year schedule instead of the usual 39 years, thus lowering the taxable income even faster. In some cases, the Tax Cuts and Jobs Act of 2017 will even allow investors to take a 100% tax depreciation deduction toward the value of the property in an owner’s first year of owning the property. This law is applicable up until at least 2025.

 

2. 1031 Exchanges for Tax Deferral

The amount of the bill is dependent upon the size of the gain and the prevailing capital gains tax rate at the time of sale.  So, a property owner’s enthusiasm about a profitable sale can be quickly dampened upon the realization that a big tax bill is likely to follow. Section 1031 of the Internal Revenue Service Tax Code allows an investor to defer taxes on the profitable sale of a property as long as they “exchange” the sale proceeds into another property that is considered to be “like kind.” There is no limit to the number of 1031 Exchanges that can be completed so, in theory, an investor could complete a series of successive exchanges over time, allowing their profits to grow tax deferred indefinitely.

Depending on the specific needs of the investor, there are four types of 1031 Exchanges that can be utilized:  the like-kind exchange delayed exchange, reverse exchange, and construction or “improvement” exchange.  Further, on occasion, the replacement property could be located in a tax-advantaged district, known as an opportunity zone, that can add another layer of tax benefits to the investment. Investors and business owners who are smart about their use of 1031 Exchanges, can grow their portfolio over time to include bigger and bigger properties based on their realized tax savings. 

 

3. Deductible Non-Mortgage Expenses

There is a list of other expenses that are deductible for a commercial real estate investor. Owning and maintaining a commercial property involves time, effort, and other expenses.  Therefore, a commercial real estate owner can deduct costs related to maintenance, management, upgrades, repairs, renovations, and other operations-related activities. Even when an investor has to travel for property-related reasons, those expenses are also deductible. That includes travel expenses, hotel expenses, and a portion of dining expenses. Other non-mortgage expenses that are deductible include the cost of attending educational events, conferences, seminars, and events related to real estate.

 

4. Minimized Tax for Beneficiaries

When a commercial real estate owner passes away and leaves property to a beneficiary, the heir does not have to pay taxes on the full value of the property. 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. As the new owner of a commercial property, the heir (beneficiary) is only required to pay taxes on the increased value of the property from the time it was purchased until the time it was passed on to the beneficiary. 

For example, if a property were purchased at $1 million and was worth $1.5 million when the investor passed away, the beneficiary would only be responsible for the $500,000 of appreciation on the property. Heirs of a commercial property who decide to sell only pay tax on the increased value from the time of inheritance.

 

 

5. Opportunity Zones

Opportunity zone funds were introduced as a tax incentive in 2017 as part of the Tax Cuts and Job Act to encourage growth in over 8700 opportunity zones across the US. Opportunity zones are a way the government encourages individuals and businesses to invest in certain communities to promote economic growth.

These geographic regions have been identified as low-income census areas, they are some of the country’s most rural and distressed areas and are targeted for job growth and economic stimulus. Real estate investors can capitalize on opportunity zones by rolling qualified capital gains into an opportunity zone fund, putting the capital gains they earned from selling an investment property into an opportunity zone fund, allowing them to defer or pay no capital gains tax on their original investment within 180 days of the sale of an asset. 

 

CONCLUSION

Some of the greatest benefits of investing in real estate are the available tax breaks. Still, the barrier for many is being unaware of these opportunities and how to take advantage of them. Understanding which investment property tax benefits are at your disposal is one of the best ways that real estate investors can achieve long-term wealth. Take advantage of these tax breaks and ensure you stay on the path to financial freedom while protecting yourself from avoidable fees.

There are many potential tax benefits of investing in real estate to be enjoyed by current or aspiring real estate investors. No matter if you’re looking to pick up a single rental property, or build out an entire portfolio of multifamily or multi-unit buildings, you may be surprised at just how many tax deductions stand to be reaped.

 

As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.