Commercial Real Estate Tax Benefits

Updated on July 29, 2020

Depreciation, 1031 Exchange, Long Term Capital Gains

In this article, we’re going to briefly explain why real estate is a truly tax-advantaged asset class. First, we’ll talk about depreciation.

As time goes on, history has shown real estate overall as an asset class goes up in price. But one of the great advantages of real estate investment is the ability to depreciate an “appreciating asset.” While we can’t depreciate the land component of a piece of real estate, the improvements and structures on the land are fair game. Apartments are depreciated over 27.5 years, and other commercial assets over 39 years. 

This means that we are allowed to “write off” 3.63% or 2.56% respectively of the value of our structure on our income tax each year. The mortgage interest can also be deducted when filing your real estate taxes. When acquiring real estate, the depreciation write-offs can create a nice tax rate. You can also implement a cost segregation study that will allow you to accelerate your depreciation expenses on your commercial real estate property, providing you with even more taxs breaks and tax savings. 

The IRS is not stupid though. When you sell your asset that has been depreciated, you’ll ultimately realize a gain on the sale price versus your depreciated cost basis, so there isn’t really a truly free lunch…or is there? 

To defer your capital gains on a commercial property you execute what is known as a 1031 exchange. I won’t get into the nitty-gritty details of how to stay compliant in the IRS’ eyes when real estate investing, but the premise is actually simple. The taxman will allow business owners to defer capital gains into the future if you “trade” or “exchange” your asset for another one of “like-kind.” What this allows you to do is to sell your property, and quickly purchase another one, all the while incurring no capital gains do to the referral.

For instance, you have a cost basis of $1 million dollars in a property that you find a buyer for at a price of $5 million. Instead of having a $4 million dollar capital gain and paying a big chunk in taxes, you can unload your $5 million property and “immediately” purchase a different asset all the while deferring your $4 million capital gain into your next property. You’ll now have a $1 million cost basis in your new asset. It is the greatest tax cut or tax deduction that exists when in actuality it’s just a deferral. 

The theory is to continue to execute profitable deals and roll into larger ones all the while deferring the property taxes into eternity. Eventually, you will die, and your heirs will take over with a stepped-up basis. What’s really special is that the taxable income you’ll receive from the larger asset is not affected in any shape, manner, or form.

Savvy commercial real estate investors utilize 1031 exchanges to “trade-up” properties to defer capital gains taxes and how they depreciate “appreciating” assets. These are some of the major tax benefits we can take advantage of opportunistic real estate investors. The other big tax advantage associated with owning rental property is the treatment of capital gains when we sell a property.

After holding property for one year, the capital gain from a sale of real estate in the US is currently subject to long term capital gains treatment. This is typically less from a percentage standpoint than our corresponding “ordinary income” tax brackets.

Our rental income or cash flow is also considered passive income, which provides certain benefits compared to ordinary income as well.

By purchasing commercial real estate investments, you are also able to convert ordinary earned income into passive income which can add up to savings over the course of time.

If you have any questions regarding the real estate investing industry, the team at First National Realty Partners is just a phone call away. We’re here to answer your questions and provide guidance about your investment opportunities. If you would like to know more about the benefits of private equity commercial real estate investing, please don’t hesitate to reach out. Our team is built with the best industry leaders, utilizing proven strategies that create great investment opportunities for you. Contact us any time when you are ready to learn more about the possibilities of investing in commercial real estate.

Access Our Deals