Investing in commercial real estate can offer a steady income stream that’s often higher than typical yields on stocks and bonds. Stepping into the world of commercial real estate investment can be attractive for a number of reasons, but the main one to note is the tax benefits. The numerous tax benefits from commercial real estate investments can offset taxable income. Some of these to note include property management expenses, depreciation deductions, and regulations such as the 1031 exchange can even delay or exclude taxes altogether.
Nonetheless, to fully utilize commercial real estate’s tax advantages, you need to know what they are and understand how they work. Let’s review five of the most common areas in commercial real estate investing that can help reduce an investor’s tax bill.
1. Depreciation Deductions
As mentioned previously, depreciation deductions are one of the ways to offset income. Commercial real estate can be treated like any other physical asset, and because of that, it has the ability to wear down over time. This gives investors the opportunity to deduct a certain amount of their income taxes yearly in order to account for this. Investors can take other steps to ensure that they can take larger depreciation deductions by working with industry professionals to conduct a cost depreciation study. This helps to identify depreciation in several areas of a commercial space and realize those benefits within a shorter period of time. Taking advantage of the depreciation deductions available is one of the best tools for maximizing the tax benefits of commercial real estate investment. The IRS allows investors to depreciate commercial buildings over a 39-year period, while residential buildings are permitted over a 27.5-year period.
2. Interest Expense Tax Deductions (Mortgage and Non-Mortgage)
Being able to deduct any interest paid on a commercial mortgage from federal income taxes is another important tax benefit. This is especially beneficial if the investor is utilizing a type of higher-interest financing. In addition to mortgage tax deductions, commercial investors can write off property repairs and maintenance costs, as well as some property management expenses.
3. 1031 Exchanges
Being able to deduct any interest paid on a commercial mortgage from federal income taxes is another important tax benefit. This is especially beneficial if the investor is utilizing a type of higher-interest financing. In addition to mortgage tax deductions, commercial investors can write off property repairs and maintenance costs, as well as some property management expenses.
4. Turning Losses Into Gains
While the goal of commercial real estate investment is to increase wealth as much as possible, if the investor suffers a loss, they may be able to take it as a tax deduction. However, this is dependent on numerous factors. There are typically three different taxpayer classifications when we are talking about commercial real estate investment rental losses, and they break down as follows:
- Investors making less than or equal to $100K per annum.
- Investors making more than $150K per annum.
- CRE (Commercial Real Estate) professionals: If the investor is an authorized CRE professional according to the IRS, there’s no limit on the number of losses the investor can take in the year.
The potential benefits of being a designated CRE professional inspires some investors to decide to leave their full-time professions behind to pursue a career in real estate investment and property management. This move is particularly appealing if they have a portfolio that generates rental income that exceeds annual expenses.
5. Reduction of Tax Burdens for Beneficiaries
The tax benefits are far-reaching and easily passed to an investor’s heir(s). For example, if an investor purchases a commercial space that costs $4 million, and the value increases to $5.5 million before the investor is deceased, the beneficiaries will only pay taxes on the $1.5 million that the property has appreciated, not the entire sale price.
While there are many benefits to commercial property real estate investment, there are also many tax implications. To best understand the advantages and disadvantages, it is wise to work with a qualified tax professional who knows the industry to help navigate the financial benefits and changes for this tax year and beyond.
Landmark Title delivers more than four decades of expertise in escrow and title services for the commercial and residential real estate industry. As a part of our escrow and title services for owners and investors, we work closely with attorneys, commercial brokers, developers, lenders and more to help navigate complex transactions. If you are interested in learning more about our process and previous work history, get in contact here. We’re excited to help you on your journey of commercial real estate investment and realizing its many benefits.