Tax Benefits of Investing in Commercial Real Estate


Stocks, financial products, and bonds are surely a great investment asset, but nothing compares to commercial real estate, which comes attached to multiple tax benefits. With the growing depreciation related to mortgage assets and tax benefits incurred, these benefits are sure to provide a great difference in returns, especially when dealt with for a prolonged period. However, to completely utilize the potential of the tax benefits with commercial real estate, it is important to understand how it works. 

Best ways to use commercial real estate for reducing the taxes for investors

1.   Income tax depreciation deduction

Similar to any other physical asset, any asset in the commercial real estate market will completely wear down with time. Given this, investors have the option to deduct some amount from their income taxes every year owing to this reason. For now, the government does have the option to depreciate every commercial property for over 30 years and residential properties for over 20 years. 

For prolonged depreciation deductions, investors can also look at some other options to make the most of the depreciation value. In several scenarios, investors can reach out to engineering firms to perform a thorough depreciation study, where they will check the different parts of the property and identify smaller parts that are eligible for shorter depreciation time. While this form of cost segregation can be applied to both commercial and multifamily properties, it is ideal for multifamily properties.

Does bonus depreciation have an impact?

A cost segregation study can help accelerate the depreciation; investors can also opt for quicker forms of depreciation, such as bonus depreciation. As per the new tax regulations, several investors opt for 100 percent of the property’s value to be deducted from depreciation in their very first year of ownership, up to 2025. 

Recapturing depreciation

Given that depreciation has multiple benefits, investors will go back to legal authorities when they decide to sell their business, projected as recapturing depreciation. So how is the depreciation recapture triggered? It is triggered when a property owner decides to sell their property for the adjusted cost basis of property, which includes the original cost minus the cost of the property and any depreciation deduction that the owner has availed.

For example, if the owner decides to sell their property after ten years for over 5 million dollars (calculated by considering the original price, 6 million dollars, minus the depreciation received for 1 million dollars), this is when the depreciation recapture will be triggered. Due to this situation, the property owner will have to pay income tax regularly on the sale amount of the property rather than the tax rate for capital gains, which is quite less. 

2.   Tax deduction – Interest expense

Another advantage of the commercial real estate tax is that you have the leverage to deduct any sort of interest that you have paid on a commercial mortgage. For example, if a borrower in the commercial real estate industry has paid $10000/month in a mortgage, $2000 is interesting, the mortgage deductions that they are looking at is $24,000 for one year. This can have a greater impact if the borrower chooses the financing options with higher interest rates, for instance, a construction loan. 

3.   Tax deduction – Non-mortgage

Adding to the mortgage interest costs, multifamily and commercial real estate owners can easily deduct maintenance costs, property repairs, expenses related to the property, and several other operating expenses that are related to their income taxes. This will also be inclusive of travel expenses from and to the property, including the hotel expenses along with beverage or food costs of up to 50 percent. Investors are also permitted to deduct the costs related to real estate conventions, conferences, and similar other events. 

However, in the year that the property has been brought, the owner cannot consider deductions related to renovations and furnishings. Rather these things will have to depreciate along with the property over time. 

4.   Understanding how tax losses benefit you

Investors always want their property to make money and that too in abundance. However, if there are any losses associated with the investment in the commercial real estate sector, you will consider them as tax deductions. This will vary depending on multiple things depending upon your income and assets. 

Since the tax benefits attached to commercial real estate are phenomenal, many investors have quit their full-time profession and ventured into this industry, especially when the income generated from rentals is much higher. In other scenarios, they will get their spouse to be involved as a full-time property manager and make the most of the tax deductions. 

5.   Commercial real estate tax benefits

The legal authorities will usually bill taxes at the regular tax rates for the investors every time someone has taken out funds from the banks, sold a property, and taxes related to capital gains. However, this does not apply to private authorities. 

6.   Deductions – Qualified Business Income

Another complex form of deductions is the qualified business income deduction. The deductions in this particular income source are related to the income generated from passive sources, and also lets the individuals deduct 20 percent of the qualified income. However, getting the exact amount to be deducted can be difficult. 

7.   1031 deductions

One thousand thirty-one exchange deductions are among the most helpful tools commercial real estate owners can utilize. This kind of deduction allows deferments to the legal authorities as long as they exchange their existing property for similar properties. 

With so many varied options available in the market, every commercial real estate owner needs to consult with experienced tax professionals to understand the taxes better, what kind of options to choose, and how to work around them. The complexity of real estate taxes can be extremely high.

The more effort you add to the documentation and preparation process, the more money you will have saved in the longer duration. Let’s not forget this will also help avoid the unpleasant visit from the legal tax authorities. 

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