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Tax Deductions for Commercial Property

Tax season is upon us. Learn what tax deductions you can claim this season.

Apr 23, 2021 by Lea Uradu
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Learn about how you can reap the rewards of investing in the most tax-advantaged asset class in America.

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Investing in commercial rental real estate is extremely financially rewarding. Whether you choose to invest in a hotel or a Class A office building, the benefits of investing in commercial real estate are many. Among the perks are the following:

  • A higher rate of return on investment as compared to an investment in residential real estate.
  • A healthy amount of capital appreciation on the rental property.

While there are many perks associated with this investment strategy, these perks don't come without a few tax considerations. Below we'll explore some of the many tax breaks you should consider this tax season.

Deduction for depreciation

One of the biggest tax savings tools you can take advantage of as a commercial rental property owner is depreciation. Depreciation is the process of recovering the cost of a tangible asset over the use life of the asset. Under the Modified Accelerated Cost Recovery System (MACRS), the depreciable period for commercial rental property is 39 years. This means you can claim the depreciation deduction on your commercial rental property over a period of 39 years. This will create huge tax savings. It's important to note that depreciation can only be claimed on the structure and not the land. Also, you should be aware that you cannot claim bonus depreciation on the property, because bonus depreciation can only be claimed on property that has a useful life of less than 20 years.

Utilizing a cost segregation study

While it takes 39 years to depreciate the building and you will not be able to claim bonus depreciation, if you choose to utilize a cost segregation study, you can depreciate the land improvements and the internal contents of the building within a shorter window of time. Using this strategy will allow you to depreciate land improvements and interior contents over a period of five, seven, or fifteen years. Since the useful life of the improvements and internal contents of the property are all under twenty years, you may also be able to take advantage of bonus depreciation on those assets.

To take advantage of this strategy and to claim a deduction for depreciation, it's in your best interest to consult with a tax advisor. You will also need to consult with a team of qualified engineers to assist you with the cost segregation study. Also note that when the property is sold, you'll be subject to depreciation recapture and have to pay depreciation recapture tax. This is another important point to speak with your tax advisor about.

Section 1031 tax-deferred exchange

Another tax savings strategy that will allow you to defer your capital gains tax until a future year is a Section 1031 like-kind exchange. This is an ideal strategy for commercial real estate investors who plan to relinquish real estate investment property and acquire another investment property within the specified time period. Real estate investors can use this exchange an unlimited number of times to prevent exposure to capital gains tax. This is great news given that the long-term capital gains tax rate for the highest income earners is 20%, but before delving into the world of like-kind exchanges, you should review the rules of engagement because section 1031 exchanges are quite complex. The good news is that we have a great article with detailed information that can be found here.

Qualified Business Income deduction

If you're a real estate investor and you actively manage your commercial property, you will be eligible to claim the Qualified Business Income deduction (QBI). QBI allows for a 20% deduction, and if you're eligible to claim the deduction, you'll only pay taxes on 80% of your qualified business income.

Mortgage Interest deduction

In addition to the depreciation deduction, you can also claim a mortgage interest deduction for interest paid on the mortgage of the commercial property. Where you'll claim this deduction on your tax return depends on your reporting requirements (Schedule E versus Schedule C).

Opportunity zones

If your commercial property is located in an opportunity zone, then you're in for a special tax treat. If you hold an eligible property, you'll be able to defer the capital gains used to fund the investment if those funds are timely invested into an opportunity zone fund. Implementing this strategy will require a high degree of technical knowledge, so consulting with your tax advisor is an essential step to being able to defer your capital gains.

Millionacres bottom line

With the May 17 (June 15 for expats) extended deadline looming, considering the type of tax deductions you can claim on your commercial rental property is pertinent. Many of the available deductions require you to work with a skilled professional. Never embark on this journey alone -- always hire a tax advisor. If you haven't found a trusted advisor already, you can file IRS Form 4868, Application for Automatic Extension of Time. This will give you more time to find a qualified professional to help you maximize your tax deductions this tax season.

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