Investing in commercial real estate can be hugely rewarding, but high taxes often prevent commercial real estate investors from realizing their full potential. Fortunately, with the right tips and strategies you can minimize your tax burden to help maximize profitability – that’s why we’ve put together a comprehensive guide! After reading it through you’ll have all the tools needed to reduce taxes on your investments and secure bigger returns for yourself as an entrepreneur.
Investing in real estate is an excellent way to increase your wealth and even decrease taxes. Yet, commercial property investing can be more demanding than residential investments due to the high tax obligations that accompany it. Happily, there are some tactics you can use which will minimize your commercial real estate investment levy burden while allowing for maximum returns on the venture.
Key Takeaways
- Understand the different types of taxes associated with commercial real estate investments and how they can be minimized.
- Utilize deductions, exemptions, credits, and allowances to help reduce your tax liabilities.
- Take advantage of capital gains deferral options available such as 1031 exchanges, which allow you to delay or avoid paying capital gains taxes.
Table of Contents
Understanding the Tax Structure for Commercial Real Estate
Explanation of property taxes
If you’re a homeowner, you’re no stranger to property taxes. Each quarter or semi-annually the local tax collector will send along an invoice, detailing the amount owed based on your home’s worth. Commercial properties follow similar rules – with one key difference: these taxes are calculated using commercial real estate values instead of residential ones.
Property taxes are an essential part of municipal government funding, based on the current tax-assessed value of commercial properties. Local governments annually assess all property values in their jurisdiction and use this as a basis for creating each individual’s annual bill to keep local services running smoothly.
To calculate your annual property tax bill, you need to multiply the value of your apartment building by a local rate – in this case 1.25%. Assuming $2 million worth of valuation on the building, that would yield two payments of $12, 500 due semiannually for an overall total cost per year of $25,000.
Commercial property taxes are a complex issue, but there are two main points to consider. The value of your commercial property is the key determinant in how much you’ll pay annually; and local entities like towns or school districts – not state or federal governments – will collect these payments, which aid them in providing necessary services for their communities.
Explanation of income taxes
The Internal Revenue Service (IRS) imposes the federal income tax on the annual profits of individuals, businesses, trusts, and other legal entities. Federal income taxes are imposed on all forms of taxable income, including wages, salaries, commissions, bonuses, tips, investment income, and certain forms of unearned income.
The U.S. federal income tax is essential to the country’s functioning! This fundamental source of income relates to different forms of earnings, including wages and salaries as well as some types of unearned income – all of which contribute to the total taxable amount of an individual. This requirement, implemented by the Internal Revenue Service, guarantees that citizens are held annually accountable for their financial achievement.
Explanation of other relevant taxes
For real estate purchases, value-added tax (VAT) is an essential consideration. It’s a consumption tax applied when the property gains in value due to renovations or other improvements – not from how much it was originally appraised for. The amount of VAT paid by the buyer, therefore, depends on what they ultimately pay for the property instead of its initial valuation.
The government plays a crucial role in providing core infrastructure to citizens. As Miller and Oats stated in their book on international taxation, the free market often fails to provide fundamental public goods such as security of life and property – items that people cannot purchase directly. Therefore, governments must take action for these essential services to be available.
Strategies for Reducing Property Taxes
Challenge the property’s assessed value
Despite the potential upside to appealing your assessment, only a small percentage of people are taking advantage. In fact, in the past five years across the country, we’ve seen an 18% rise in property tax – proof that it’s becoming increasingly important for homeowners to stay informed and consider their options when assessing their evaluation.
Take advantage of tax abatements and exemptions
Local governments can establish a competitive advantage in their communities by employing tax abatements as an incentive to draw and retain businesses. By offering temporary reductions of general business taxes, local governments are creating opportunities for success among their businesses – further fostering economic growth within the community at large.
For example, Ratner Steel Company recently made a significant investment in Portage, Indiana with the expansion of its local plant and purchase of a $2.5 million steel cutter. The City offered an attractive abatement that allows for no taxes on the equipment for the first year followed by five years’ worth of tax payments at completion. This is great news as it incentivizes continued growth and development within this town!
The city showed its support for the plant expansion project with a 10-year tax abatement, in exchange for an employment boost that would provide job opportunities and increased property taxes. With 30 new positions being added to the local economy, both businesses and residents will benefit from this beneficial agreement.
Tax abatements can be a great way to save money – and property taxes aren’t excluded! If you believe that the assessed value of your home is too high, don’t hesitate to get in touch with your local tax assessor. You could receive an abatement which saves dollars off your annual bills.
In many places, you can save money on your property taxes by preserving and updating sites of historic importance. If a nonprofit operates within the building you own, it could qualify for tax abatement based on its exemption status – meaning more savings in your pocket.
Negotiate a payment plan
The IRS understands that sometimes tax payments are delayed – and they’re often willing to work with taxpayers on installment plans. To ensure a successful negotiation, it’s important for filers to reach out promptly and be proactive about finding the best solution. Here we provide an overview of available options plus steps you can take if your taxes are overdue:
Taking advantage of an installment agreement could be the most cost-effective and least damaging way to ensure your financial security. When making a request with the IRS, remember that you will have higher chances of success if you follow certain steps:
- Make sure to communicate with the IRS that you plan on settling your debt within six years, or even better yet, three.
- Set your sights high. Your monthly payment should rival or even surpass what the IRS believes it can garner from you with an instigated negotiated settlement.
- Make sure to stay on top of your tax obligations by setting aside a portion of your income each month. Calculate what you owe using IRS criteria, such as subtracting household expenses from total earnings and then sending the difference in payment directly to the government body.
It’s important to remember that, until delinquent taxes are paid in full, any unpaid amount may incur penalties and interest. Agreeing on a payment plan is the best way to avoid these charges.
Consider a real estate investment trust (REIT)
Investing in real estate comes with a range of benefits, but it’s rarely possible for the average person to enter the market and make money. That’s where Real Estate Investment Trusts (REIT) come into play – by pooling capital from numerous commercial real estate investors, REITs create opportunities to benefit financially without having to become a property magnate yourself!
By working with a broker or financial advisor, you can purchase shares of publicly traded REITS and participate in mutual funds & exchange-traded funds for added diversity to your portfolio. Buy into non-traded real estate investments as well to gain even more exposure to this market.
With over 145 million U.S investors, Real Estate Investment Trusts (REITs) are becoming a popular addition to defined-benefit and defined-contribution investment plans. Whether owned directly or through retirement accounts such as 401(k), REITS offer many opportunities for long-term growth potential while providing stability in market volatility according to expert researchers of Nareit, located in Washington D.C.
Strategies for Reducing Income Taxes
Depreciation and cost segregation
By combining depreciation deductions and cost segregation, businesses can lower their overall liability to the IRS – giving them more resources for growth. Plus, improved cash flow gives companies a greater ability to make long-term investments that further solidify success in today’s competitive economic climate.
While some utilize all of the real estate benefits available through building depreciation, many still overlook qualified components necessary for maximum benefit from these strategies; teaming up with a knowledgeable advisor is key here.
Write off repairs and upgrades
As a rental property owner, you have the opportunity to save on taxes by claiming deductions for qualified expenses. These can include mortgage interest, real estate tax payments, and utilities as well as operational costs and any repairs needed over time.
Take advantage of tax credits
A tax credit can reduce the amount of tax you owe by the same amount. The provision of tax relief or the encouragement of taxpayers to participate in particular activities are both possible outcomes of the usage of tax credits by the government.
A tax credit can reduce your taxes by the same monetary amount. The government utilizes tax credits to encourage taxpayer participation in specific activities and to provide tax relief.
Child tax credit (CTC), earned income tax credit, first-time homebuyer credit, child and dependent care credit, adoption credit, education credit, and retirement savings contributions credit are among the IRS tax credits. Available tax credits and deductions fluctuate frequently. Verify that the credits on which you are depending will be accessible for any given tax year.
Consider a like-kind exchange
Looking for a way to upgrade your equipment, artwork, or real estate investments? Consider utilizing the tax-deferred benefits of a like-kind exchange! Prior to December 2017, this option included exchanging one business for another and other tangible property. Post that date it narrowed its scope solely towards businesses and real estate exchanges – but has still proved highly beneficial as an effective tool in managing capital gains taxes on those transactions.
And if you’re a CRE investor, you might want your business to go green as a lot of customers and investors are now preferring this (and it has a lot of advantages for you and your business, too!) read on here to find out more.
Other Tax-Reducing Strategies
Create a holding company
Some of the most widely known and successful companies never make a single product or provide any services. Consumers will never cut a check to these companies. How can this be? Well, the reason for this is due to the existence of holding companies.
Holding companies are businesses that exist to hold assets. These assets can include hedge funds, intellectual property, and even (or especially) other companies. Businesses owned by holding companies are often referred to as “subsidiaries.” There is no limit on the type of company that can be held by a holding company; for example, a corporation may well be the holding entity of another corporation.
Tax Advantages of Holding Companies
Starting a holding company can be extremely beneficial to your business and investments. Subsection 112 of the tax code allows individuals who own a holding company to receive dividends without creating any taxes. This creates an incredibly efficient process in which those same dividends could either become more cost-effective via payments or further invested into another subsidiary – both key steps for personal growth.
By using a holding company, businesses can take advantage of the tax benefits associated with offsetting losses from one subsidiary against profits earned by another. This creates an opportunity for each subsidiary to reduce their overall liability when filing taxes – and in some cases, wholly-owned subsidiaries may not be taxed on the revenue at all.
Utilize passive loss rules
Passive activities involve business operations you have little to no influence over. Regular, continuous involvement on your part however is what can turn an activity into a non-passive one – so jump in and take control! Rental properties are often associated with passive investments; yet even if you frequently participate in running the property’s day-to-day tasks, it may still be considered passive by definition.
For rental real estate activities, you may qualify as a ‘real estate professional’ – allowing your activity to be considered non-passive. There is also the exception of active participation, which has its own set of distinct rules from material participation.
Publication 925 can provide you with all the rules and guidelines needed to ensure that your income or losses from a passive activity held through a publicly traded partnership (PTP) are determined accurately. Additionally, it contains key information about material participation along with who is considered a real estate professional for tax purposes.
Consider a 1031 exchange
Tax deferment has never been more attainable! An IRC Section 1031 Exchange allows savvy investors to keep their hard-earned capital gains tax efficiency intact while selling real estate investments or properties used for business purposes. Up to 35% savings can be attained through these beneficial Exchanges – a great incentive in today’s competitive market.
How to Reduce Taxes with Commercial Real Estate FAQs
How can I finance a commercial real estate purchase?
Investing in commercial real estate can be an exciting way to generate long-term revenue streams. From term loans and SBA loans to lines of credit and portfolio financing options, there are many ways for businesses to access the capital they need when ready to make their move into a new property or invest in improvements on existing premises. These loan terms generally cover five up until ten years with amortization plans that reach as far out as 25 years – though this does little more than delay the inevitable balloon payment due at its conclusion.
How do I determine the value of a commercial property?
Utilizing recent comparable sales as a basis for value is the most prevalent strategy for valuing commercial assets. Analyzing recent comparable property transactions yields the average price per square foot, which is then used to establish the property’s value.
What are the tax implications of owning commercial real estate?
The tax implications of owning real estate can vary widely, depending on the particular asset and the structure of its ownership. In general, owners are subject to income taxes on rental income, capital gains taxes upon the sale of the property, as well as depreciation deductions for buildings and other improvements.
How do I manage and maintain a commercial property?
Owning a commercial property can be an exciting and potentially rewarding venture – but it also requires careful management. To help streamline operations, maximize financial returns, and create a pleasant environment for tenants, investing in specialized software is key.
Additionally, familiarizing yourself with the features of your space as well as its limitations will give you valuable insight into potential risks that could arise down the line; steps such as conducting inspections or providing online support systems ensure these issues are dealt with swiftly before they become costly problems.
With sound planning combined with modern technology tools at hand – managing commercial properties needn’t remain daunting.
What are the benefits and risks of investing in commercial real estate?
Investing in commercial real estate can be a great way to diversify your portfolio, benefit from income and price appreciation opportunities–and potentially enjoy favorable tax treatment. However, it also requires careful consideration: the cost of entry is typically high, and managing these investments often takes considerable effort.
Conclusion
All in all, if you own commercial real estate it is important to be aware of the different strategies that can help you reduce your taxes. Tax laws are always changing, so it’s a good idea to seek professional advice to make sure you’re taking advantage of all the deductions and loopholes that are available. At toljcommercial, I offer free consultations so don’t hesitate to call or schedule an appointment today. I’ll be happy to go over your specific situation and recommend some strategies that could save you money.
