Dreading tax season? Looking for a way to invest so next year is better? Commercial real estate (CRE) might be your answer. Commercial real estate investment has long been a favored strategy for investors seeking to diversify their portfolios and generate stable returns. Beyond the benefits of cash flow and property appreciation, one of the highly impactful advantages is the range of tax benefits available to commercial real estate investors. These tax incentives can significantly enhance the overall return on investment, making CRE an even more attractive option. Here are just a few of the reasons that commercial real estate investment can be an excellent choice come tax time.
Depreciation Deductions
One of the most substantial tax benefits in CRE is depreciation. Depreciation allows investors to deduct the cost of buying and improving a property over its useful life, as defined by the IRS. For commercial properties, this period is typically 39 years. This deduction can offset income generated by the property, thereby reducing the overall tax burden. It’s essential to work with a tax professional to accurately calculate and claim depreciation deductions, as the IRS has specific requirements and schedules for different types of property and improvements.
Like-Kind: The 1031 Exchange
The 1031 exchange, also known as a like-kind exchange, is a powerful tool for deferring capital gains taxes when selling a property. Instead of paying taxes on the gains from the sale, investors can reinvest those proceeds into another “like-kind” property. This process can be repeated indefinitely, allowing investors to defer capital gains taxes until they eventually sell the final property without reinvesting. It’s a strategic way to grow your investment portfolio while deferring taxes, but it requires strict adherence to IRS rules and timelines.
Opportunity Zones
Investing in designated Opportunity Zones can offer significant tax advantages, including deferral of capital gains taxes and potential step-up in basis, which can reduce the taxable amount of a future sale. Opportunity Zones are economically distressed communities where new investments may be eligible for preferential tax treatment. By investing in these areas, not only can investors benefit from tax incentives, but they can also contribute to the economic development and revitalization of these communities.
Mortgage Interest Deduction
For CRE investors, the interest paid on a mortgage for a property is typically deductible from their taxes. This deduction can significantly reduce the net cost of borrowing, making it more affordable to finance commercial properties. It’s an important benefit that can improve cash flow and increase the overall return on investment.
Pass-through Deductions
The Tax Cuts and Jobs Act introduced a new deduction for income from pass-through entities, which includes many real estate investments. Investors can potentially deduct up to 20% of their net rental income or business profits from the property, reducing their taxable income. This deduction is subject to various limitations and conditions, so consulting with a tax professional to understand how it applies to your specific situation is crucial.
Enhanced Cost Segregation
Cost segregation is a tax strategy that allows investors to accelerate depreciation deductions by identifying and reclassifying personal property assets. By segregating the costs associated with a property into different categories that can be depreciated over shorter periods (typically 5, 7, or 15 years), investors can significantly increase their upfront tax deductions, improving cash flow in the early years of the investment.
Conclusion
The tax benefits of commercial real estate investment are both varied and valuable, offering investors multiple strategies to maximize their returns while minimizing tax liability. However, navigating the complex landscape of real estate taxation requires a thorough understanding of the laws and regulations. Working with experienced tax professionals and financial advisors who specialize in real estate can help investors leverage these tax advantages effectively. WIth all that in mind, getting in touch with a CRE brokerage could be your first step toward a happier and more lucrative tax season next year and for decades to come.
If you are interested in a free broker opinion of value or just learning more about investing in commercial real estate in Maryland, Virginia, or Washington DC, please contact us. Avenue Real Estate is a leading full service commercial brokerage in the Baltimore and Washington DC areas and we would love to help you explore your options and make informed decisions about commercial real estate investments.