When thinking of investing in commercial real estate or a multi-family property, it is vital to have an effective strategy. It is the key to success.
When ignored, you might have to pay a large portion of your profit for outsized tax bills. There are many taxes an investor has to pay for the investment, but none is more important than the capital gain taxes.
Capital gain tax is generally paid off when the investor makes a profit by disposing of an asset, expensive collectibles, real estate property, etc. This tax is not applicable for ordinary business or personal income or on the sales of the primary residence.
Capital gain tax rates for multi-family and commercial real estate
You must know there are two types of capital gain taxes, namely short-term capital gain taxes, which are for the property held for less than 12 months.
The long-term capital gains are those wherein the hold is for a year or more on the property. It is usually more expensive to opt to flip a commercial property and sell it within a year than to hold a property for a longer time.
Like income tax, capital gain tax rates depend significantly on the taxpayers’ income during the sale of the property. In the current market scenario, the long-term capital gain taxes are.
• 0 to $39,375: 0%
• $39,376 to $434,5500%: $15%
• $434,551+: 20%
Besides, in comparison, the short-term capital gain taxes are paid based on the regular bracket of the taxpayers. The federal tax rates in 2019 for single filers are.
• $0 to $9,525: 10%
• $9,526 to $38,700: 12%
• $38,701 to $82,500: 22%
• $82,501 to $157,500: 24%
• $157,501 to $200,000: 32%
• $200,001 to $500,000: 35%
• $500,001+: 37%
While 2019 federal income taxes for married taxpayers are a Joint venture
• $0 to $19,050: 10%
• $19,051 to $77,400: 12%
• $77,401 to $165,000: 22%
• $165,001 to $315,000: 24%
• $315,001 to $400,000: 32%
• $400,001 to $600,000: 35%
• $600,001+: 37%
For separate-filers:
• $0 to $9,525: 10%
• $9,526 to $38,700: 12%
• $38,701 to $82,500: 22%
• $82,501 to $157,500: 24%
• $157,501 to $200,000: 32%
• $200,001 to $300,000: 35%
• $300,001+: 37%
Since the tax system is progressive, the taxpayers need to pay only the higher tax rates on the income, which is more than the previous tax rate. For example, a single filing taxpayer with an income of $100,000 needs to pay a 24% tax rate on more than $82,500.
Capital gain tax and 1031 exchanges
The 1031 exchanges are highly loved and preferred by commercial real estate and multi-family investors. The reason behind this is the ability it offers the investors to avoid paying capital gain tax bills.
By exchanging the current property for similar commercial property, they can prevent the payment of taxes. However, specific rules must be followed, as the new cost of the latest property must be as close to the original one. Remember here, the person’s residence isn’t eligible.
Besides this, the investor cannot have a new property lined up immediately. However, they can make use of the reverse 1031 exchange to put off purchasing a unique real estate property for at least 180 days. 1031 exchange also allows the borrowers to defer the payment for depreciation recapture taxes, although they need to pay.
Other essential considerations
• Depreciation deduction and recapture tax
When you are the owner of a multi-family or commercial real estate property, then remember that the property will age naturally; it requires proper maintenance and repair services, and finally will become less valuable.
Fortunately, the federal government allows the property owners to benefit from the property depreciation deductions against the income taxes to represent the loss in value. The depreciation must be over 27.5 years for multi-family properties, while for a commercial real estate property, the depreciation must be over 39 years.
When an investor chooses to sell the property, they still need to pay tax on the depreciation deductions they have taken. However, it is applicable only when the property is sold for a higher amount than its depreciated value. Thus, it is known as the depreciation recapture tax.
For instance, when an investor makes an investment of $1 million in an apartment building and takes out $200,000 for depreciation deduction against the federal income tax, they will have to pay off the depreciated amount when selling the property above a cost of $100,000.
The investors must know they can consider accelerated depreciation deductions by ordering a cost segmentation study. It is done to identify the property parts that can depreciate in a short period.
Further, the temporary Tax Cuts and Jobs Act provision of 2017 offers investors large depreciation deductions during the first year of their property. It is essential to understand that the accelerated reductions will still be paid later on.
• Capital gain taxes and opportunity zone programs
Jobs Act and Tax Cuts of 2017 presented a new tax incentive program known as the Opportunity Zones program. It allows commercial real estate and multi-family investors to defer their capital gain taxes until 31st December 2026, by investing the amount in a qualified opportunity fund. The program was designed to revitalize the low-income census tracts by encouraging others to invest in these areas.
No doubt the capital gain tax deferral for seven years is impressive. Still, the program also offers other incentives, like those who keep their money in QOF for at least five years before the end term, which is 31st December 2026, then they can gain a benefit from a 10% reduction in the capital gain tax. Those investors who keep the money for seven years in QOF before 31st December 2026 can benefit from a 15% reduction in the capital gain tax.
• Capital gains and tax loss harvesting
The opportunity zones and 1031 exchanges offer a great way to reduce the capital gain tax bills, but they are not the only ways. For example, if you own an investment that you can sell at a loss, you can benefit from the failure to offset the capital gain taxes with tax-loss harvesting. For instance, when you sell your apartment building at a taxable profit of $200,000 and sell another investment for $100,000. It will reduce your capital gain bill to $100,000.
Knowledge is the key to benefiting from capital gain taxes.
Investment in multi-family and commercial real estate property types can be advantageous. But remember, the process isn’t easy. Having a clear understanding of the potential expenses beforehand is the key to ensuring that they do not eat up the entire profit.
So, whether you wish to use the 1031 exchange or take advantage of tax-loss harvesting or other strategies, you must do thorough research about all the available choices to understand how they work and other aspects. When you have a clear idea about the process, you will make the right decision for your investment and guarantee you do not end up creating trouble.
Conclusion
Deferring the capital gain taxes isn’t easy. You might need some expert help. So do not hesitate to contact a professional to understand the operations of different strategies. The professional service will ensure you use the proper technique for the tax payment and benefit from the profits made.
In case you are looking for help, then Private Capital Investors are the best fit. The company, for years, has been helping people with their commercial real estate investments. From getting help with your investment properties to acquiring commercial real estate loans, they can offer you all the support.
The professionals here are highly skilled. They know how to make use of a situation to gain maximum benefit. So please do not wait and contact them to see the positive results.
