Does Buying Commercial Property Reduce Corporation Tax?

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May 6, 2022

Corporate Income Tax Return form

There is a lot of awareness about the common benefits of purchasing commercial property. Some of these benefits include cash flow/passive income, hedge against inflation, price appreciation, and portfolio diversification among others. However, there is little knowledge about the tax advantages of investing in commercial property. So, does buying commercial property reduce corporation tax?

Does Buying Commercial Property Reduce Corporation Tax?

Yes, under the current income tax laws, buying commercial property reduces corporation tax. There are several tax advantages investors stand to enjoy from buying commercial real estate. 

Commercial real estate properties

The tax advantages, ranging from depreciation deductions to mortgage interest deductions, can make a great difference in the returns realized by investors. This is particularly true when you consider the long-term effects of the advantages. However, to take advantage of these tax advantages, you must understand the advantages and how they work.

Depreciation Deductions 

Commercial properties, like almost any other physical asset, will wear and depreciate as time passes. This depreciation builds up and helps to offset the tax liability of a corporation. In simpler words, depreciation on commercial properties allows investors to reduce their taxes by a certain amount. 

As it stands, the IRS allows the depreciation of commercial buildings over a period of 39 years. So let’s say you buy a commercial building for $5 million, your taxes on your profit can be reduced by about $128,000 each year as a result of depreciation.

Interest Expense Tax Deductions

If you buy a commercial property, you get to enjoy a tax deduction on your mortgage interest payments. This means that the interest you pay as part of your mortgage for the year can be deducted from the tax your corporation owes.

For example, if you pay $3000 in interest as part of your monthly mortgage payments, your mortgage interest will accrue up to $36,000 at the end of the year which can be deducted from your federal taxes. This can come in handy when you have higher interest financing, like a construction loan.

Non-Mortgage Tax Deductions

Aside from mortgage interest costs, there are other costs you may incur from managing a commercial property. These range from renovations, maintenance costs, repairs, and other management and operating expenses. These costs are typically out-of-pocket expenses but they help to improve the property’s value. They are generally deductible from your taxes.

Non-mortgage tax deductions also cover the costs of traveling to and from rental properties, which include the hotel expenses and as much as 50% of the costs of food and beverage. Other expenses include the cost of seminars, conventions, conferences, and other events that are related to real estate investments.

It should be noted that expenses on general property improvements have to be depreciated over time because they cannot be deducted from taxes the year they were incurred. 

Corporate Income Tax Return form

Reduced Taxes for Beneficiaries

Commercial real estate investors are not the only ones that benefit from these tax advantages. Their heirs or beneficiaries can also enjoy significant tax advantages. 

For example, if you buy a commercial property for $4 million, and the value rises to $6 million before your passing, your beneficiaries only have to pay taxes on the value increment of $2 million and not the total value. This helps to save beneficiaries hundreds of thousands and sometimes, millions in taxes.

Deferred Capital Gains With 1031 Exchanges

Another very valuable tool for commercial real estate investors to leverage is the 1031 exchange. Section 1031 of the Internal Revenue Service Tax Code permits commercial real estate investors to defer taxes payable on the payment of capital gains, as long as they exchange the proceeds from the sale for a “like-kind” commercial property within a given timeframe. 

This like-kind commercial property cannot be lesser than the value of the relinquished property, though the properties do not have to be the same asset type. However, the exchanged property must be a commercial property located in the United States and must be identified and purchased within 45 and 180 days respectively. 

Nothing in this section limits the number of times a commercial real estate investor can keep exchanging commercial properties. However, once they make a final sale, they are required to pay the taxes on their capital gains in full. 

Tax Deductions on Commercial Real Estate Losses 

While every commercial real estate investor wants to make a profit on their properties, occasionally they make a loss. In such instances, the losses on a commercial real estate investment can be used as tax deductions. The amount lost in that year can be used to offset the taxable income, thereby reducing the investor’s liability. 

In cases where the loss is too large or it exceeds the total taxable income, it could be spread over multiple years. 

Taxes can be a difficult area to navigate when it comes to running a commercial real estate business. This is why you need the services of commercial property experts like Si Vales Valeo Real Estate. We have vast experience in handling commercial real estate transactions and the role taxes play. We can help you maximize the tax benefits available to you. 

Types of Corporations

The type of corporation you operate affects how you are taxed. Here are the types and why they determine your tax structure:

Person counting money

C Corporation

This is the most popular type of corporation among businesses and it has virtually all the characteristics of a corporation. The owners of a C corporation receive profits on an individual level and are also taxed individually. The corporation itself is then taxed as a business entity.

S Corporation

The S Corporation is created in a similar manner as the C Corporation. It is however different in regards to the owner’s limitations and tax purposes. S Corporations can have as many as 100 shareholders. Instead of the corporation being taxed separately, the shareholders bear the taxes individually. This can be a good idea for short-term investors. 

Limited Liability Company

A limited liability company (LLC), also known as a limited liability corporation, is a type of corporation that ensures that the business and owners are separated entities. It protects owners from the liability of their corporation. 

With LLCs, owners are only taxed individually and not at a corporate level and they have the ability to own multiple real estate properties under different LLCs. This is the ideal option for long-term investors. 

Frequently Asked Questions 

Is Property Tax Payable on Commercial Property?

Commercial properties that are not residential properties and are fully subject to commercial rates are not liable for the Local Property Tax. 

Is Commercial Property Taxable?

Any income that is realized from commercial properties is taxable. You can get a tax deduction for certain revenue expenses like letting agent fees and interests.

Conclusion

There are a lot of tax benefits provided by the government and regulators to ease doing business in this sector. It is always best for commercial real estate investors to consult experts who can help them save lots of dollars and avoid the possibility of unpleasant visits from the IRS.

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