When you’re starting with any investment, it’s always good to be aware of the tax implications. This is especially true when investing in commercial real estate. Because the government wants to encourage real estate investment, there are several real estate investing tax strategies that investors can take advantage of.
Tax benefits are a compelling reason to invest in commercial real estate if maneuvered correctly. Strategies like selling on an installment sales basis to defer taxes, avoiding payroll taxes on rental income, or deducting expenses related to ownership are relatively straightforward.
4 Major Tax Strategies in Commercial Real Estate For Informed Investors Primary Real Estate Investment Strategies For Tax Advantages
The tax code provides for several real estate tax strategies for minimizing tax liabilities or generating refunds. Some of these concepts are well-established and time-tested, while others are relatively recent additions. Four of these strategies are as follows:
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Depreciation
Depreciation is recovering costs to maintain investment properties through annual tax deductions. Over time, the real estate will begin breaking down, and the depreciation deduction is a recompense for the “wear and tear” of the property. For tax purposes, depreciation is always considered a net loss on the real estate investment independent of any profits realized on the property.
The allowed deduction amount is determined by the property’s market value, the property’s recovery period, and the depreciation method used. The most commonly used depreciation method is called the modified accelerated cost recovery system, which allows investors to deduct depreciation on residential property and commercial real estate for 27.5 years and 39 years, respectively.
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Self-Employment/FICA Tax
Social security and Medicare income taxes of 15.3% are split evenly between you and your employer. However, if you have no employer because you are self-employed, you are responsible for the entire 15.3%.
While rental income is taxable as standard income tax, it is not subject to these FICA taxes. Even if you are self-employed, any income relating to a rental property is immune to both the social security and Medicare taxes you would otherwise pay on either a 1099 or W-2.
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Opportunity Zone Funds
The Tax Cuts and Job Act of 2017 includes a tax incentive for investing in the country’s most rural and financially distressed areas. The act designates nearly 9,000 of these areas as Opportunity Zones, in which investors can put the capital gains earned from selling other investment properties as a means to defer capital gains tax on their original investment.
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1031 Exchange
A 1031 Exchange is the exchange of one real estate investment property for another similar property. A qualifying exchange will have either zero or minimal tax liabilities, unlike most asset swaps that are taxable at the point of sale.
This means you can roll over capital gains from one real estate investment to another, avoiding taxes until you sell the property – so long as you hold the asset for at least one year. In other words, capital gains taxes are only paid upon a final sale of a property that includes no exchange.
To qualify as a 1031 Exchange, the two properties must meet these requirements: The properties must be exchanged for a tangible asset. The new property’s value must be greater than or equal to that of the exchanged property. The property must be held for business purposes.
CONCLUSION
As an informed investor, knowing these real estate investment tax strategies is important not only for squeezing out all possible deductions but for making investment decisions as well. A comprehensive understanding of where your deductions are coming from, how they will be applied and the amounts to be expected can all help influence future strategies, whether they are personal or business in nature.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
How does a 1031 exchange work?
What should investors consider when deciding which tax strategies to use?
Investors should consider a variety of factors when deciding which tax strategies to use, including their investment goals, the type of property they’re investing in, and their overall financial situation. It’s important to consult with a tax professional to determine which tax strategies are best suited for your specific needs and goals.
