Tax-Saving Strategies for Commercial Real Estate Investors

Among the many advantages of investing in commercial real estate, the potential for significant tax savings is one of the greatest benefits. In fact, it’s one of the many reasons investors choose this asset class over any other investment vehicle.

By having the right strategies in place, investors can enhance returns, optimize cash flow, and boost long-term wealth growth.

Below, we outline three highly effective tax-saving strategies and how you can leverage them within your real estate portfolio.

1. Depreciation
2. 1031 Exchange
3. Opportunity Zones

1. Depreciation

Depreciation refers to the process of gradually reducing the value of a property over time for accounting and tax purposes. Just like a car loses value as it ages, commercial properties also experience a decrease in value due to wear and tear.

Through depreciation, property owners can deduct a portion of this reduced value from their taxable income each year, which helps to lower the amount of taxes they owe.

There are two main types of depreciation:

Straight-line depreciation, which spreads the property’s cost evenly over a specified number of years (usually 39 years for commercial properties), and accelerated depreciation, which allows for larger deductions in the earlier years of ownership, providing more tax benefits upfront.

• One effective way to achieve accelerated depreciation is through a cost segregation study. This study identifies and separates different components of a property, categorizing them based on their useful lives. For example, items like landscaping, plumbing, and electrical systems may qualify for shorter depreciation periods, such as five, seven, or fifteen years, rather than the standard 39 years for the entire building.

2. 1031 Exchange

1031 exchange, named after Section 1031 of the Internal Revenue Code, enables investors to defer capital gains taxes when selling one investment property and purchasing another “like-kind” property.

This allows investors to reinvest the proceeds from the sale without incurring immediate tax liabilities, creating a cycle of growth that enhances their investment portfolio. Investors can upgrade their holdings by moving into higher-value properties or diversifying their investments while maintaining capital for future growth.

However, two key requirements must be met for a successful 1031 exchange:

1. Timing: Investors have a strict 45-day window to identify potential replacement properties after selling the original property, and the purchase must be completed within 180 days.
2. Like-Kind Property: The new property must be “like-kind,” meaning it should be similar in nature to the original property, and it must be of equal or greater value to avoid tax penalties.

3. Opportunity Zones

Opportunity zones were established under the Tax Cuts and Jobs Act of 2017 to spur economic development in economically distressed areas. By investing capital gains into a qualified opportunity fund, investors can defer and even reduce their capital gains taxes while potentially growing their wealth. Here’s how:

• Tax Deferral on Initial Gains: Investors can defer paying capital gains tax until December 31, 2026 , or until they sell their opportunity zone investment, whichever comes first. This gives investors the chance to hold on to cash they’d otherwise owe in taxes.
• Reduction on Original Gains: If an investor holds their qualified opportunity fund investment for five years by 2026, they can reduce their original capital gains liability by 10%. Holding for seven years (prior to 2026) adds another 5% reduction, totaling a 15% reduction on the original capital gains tax.
• Tax-Free Growth on New Gains: If the investor holds the opportunity zone investment for at least ten years, any appreciation earned on the investment itself is entirely tax-free. This incentivizes long-term investment in opportunity zones, as no capital gains tax is due on new profits.

Takeaway

These three main tax benefits are just a glimpse into the many ways you can significantly enhance your overall return when investing in commercial real estate. By understanding and utilizing these strategies effectively, investors can not only maximize their tax benefits but also create a more resilient and profitable portfolio.

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Note: Although we are here to help be a resource on your investment journey, we are not licensed tax or financial advisors and always recommend consulting a professional who deeply understands the nuances of commercial real estate tax law.