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7 Tax Benefits of Commercial Real Estate: A Savvy Investor’s List

7 Tax Benefits of Commercial Real Estate: A Savvy Investor’s List

As profitable as a lucrative short-term rental investment or commercial property is, mandatory contributions are levied on it to finance government activities and public services. 

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However, investing in commercial real estate has more favorable tax benefits than investing in stocks and bonds.

If you invest in short-term rental properties or any type of real estate asset for business purposes, you can enjoy deductions that can save you hundreds or even thousands of dollars on taxes every year, leading to a considerable potential increase in your long-term returns.

Let’s look at the tax benefits of commercial real estate over the life of your investment.    

Commercial Real Estate Tax Benefits That You Should Know

Taxation can be a complicated subject, but understanding the tax benefits of commercial real estate is a must if you want to maximize your earnings. Here are seven that you should know about.

1. Depreciation Deduction for Annual Income Tax

This could be the most favorable among commercial real estate tax benefits. Most real estate assets are physical, especially commercial properties. Over time, they wear down. As an investor, you can deduct a certain amount of your annual income tax to account for the depreciation.

According to the IRS Publication 946, you can depreciate non-residential/commercial properties for 39 years and residential rental properties for 27.5 years.

So, for example, if you buy a home to invest in short-term rental investment properties worth $1,000,000, you can take approximately $36,364 (1,000,000/27.5) of depreciation each year.

In some situations, you can also take larger deductions for depreciation in a shorter period through cost segregation. This process involves professionals checking parts or areas of your property for accelerated depreciation, which often occurs in roofs and HVAC systems.        

2. Mortgage Interest Expense Tax Deductions

Commercial real estate tax benefits often include one where you can deduct any interest you pay on a commercial mortgage off of your income taxes.

Homeowners enjoy mortgage interest deductions on their tax returns, and the good news is, that commercial real estate investors are afforded the same opportunity. When you take out a loan to invest in short-term rentals or other commercial properties, you’re permitted to write off the amount of mortgage interest paid on your loan each year.

For instance, if you’re paying $20,000 per month in mortgage payments, where $4,000 of which is interest, you would be able to take a mortgage interest tax deduction of approximately $48,000 for that year.

This is especially beneficial for the first few years of your investments when interest rates are higher than the amount paid on the principal.

3. Capital Gains Tax Deferral

When you own a commercial property, such as a vacation rental, you’re granted the opportunity to postpone paying taxes for capital gains and depreciation recapture through a Section 1031 tax-deferred exchange.

Typically, when you sell a rental property, the depreciation expense is recaptured and taxed as ordinary income, with a usual rate of 20%, contingent upon your federal income tax bracket. Additionally, you’re liable for a long-term capital gains tax of 0%, 15%, or 20% on any profit from the sale.

Through a 1031 exchange, you can reinvest the proceeds in another rental property instead of remitting taxes. Termed a “like-kind exchange” by the IRS, this benefit enables capital gains tax deferral until all property ownership is liquidated.

4. Deductible Operating Expenses

This is also one of the most important commercial real estate tax benefits that greatly affect your finances as an investor. Operating costs for maintaining and managing rental properties are tax deductible.

For instance, if you spend $5,000 on property repairs and $3,000 on advertising over the year, you can deduct these expenses from your rental income.

Ordinary and necessary expenses that you can write off may include repairs and maintenance, utilities paid directly by you as a landlord, advertising costs, property management fees, leasing commissions, landscaping, pest control, property taxes, and landlord liability insurance.

5. FICA Tax Avoidance

Self-employed taxpayers are still required to pay Social Security and Medicare taxes under the Federal Insurance Contributions Act, thus the name “FICA tax”. And, the combined withholding rates for Social Security and Medicare are 12.4% and 2.9%, respectively—15.3% in total. 

So, if a taxpayer earns $100,000 annually from a business, they would owe a FICA tax of 15.3% of their income or $15,300.

Fortunately, income from rental properties is usually not considered earned income, which makes it exempt from FICA tax. This means your earnings are intact!

6. Reduced Tax Burdens for Beneficiaries

If you own commercial real estate, it’s not only you who will enjoy tax benefits but your beneficiaries/heirs as well.

Take this scenario for example:

If you bought a property for $1,000,000, and its value has increased to $1,500,000 before you pass away, your beneficiaries will only need to pay taxes on the $500,000 that your property has appreciated, saving your heirs huge amounts for taxes they have to pay.

7. Tax Advantages for Rental Losses

You might not know this, but you can deduct your rental losses from other sources of income, reducing your overall tax burden, which is known as a rental real estate loss allowance.

According to the IRS Publication 925, up to $25,000 may be deducted as a real estate loss each year as long as your adjusted gross income is $100,000 or less. However, this deduction phases out for those earning between $100,000 and $150,000. Similarly, those with higher adjusted gross incomes aren’t eligible for this allowance.

Final Thoughts on Tax Benefits of Commercial Real Estate

commercial real estate investors computing taxes

Understanding the tax benefits of commercial real estate is crucial for maximizing your investment returns. 

As you navigate the intricacies of investing, it's essential to stay informed and seek professional guidance to ensure compliance with tax laws and regulations. 

With careful planning and strategic utilization of these tax benefits, you can enhance your investment profitability and long-term financial success.

If you are a short-term investor looking to increase the ROIs in short-term and vacation rentals, speak to a short-term rental property expert.

Avery Carl

Avery Carl

Avery Carl was named one of Wall Street Journal’s Top 100 and Newsweek’s Top 500 agents in 2020. She and her team at The Short Term Shop focus exclusively on Vacation Rental and Short Term Rental Clients, having closed well over 1 billion dollars in real estate sales. Avery has sold over $300 million in Short Term/Vacation Rentals since 2017. An investor herself, with a portfolio of over 100 Doors, Avery specializes in connecting investors with short term rentals with the highest ROI potential, and then training them to manage their short term rental from their smart phone from anywhere in the world.

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