In addition to mortgage interest costs, commercial and multifamily real estate investors can deduct property repairs, maintenance costs, certain property management expenses, and many other operating expenses from their income taxes. This includes costs to travel to and from a rental property, including hotel expenses and 50% of food and beverage costs. Investors may also deduct the cost real estate investment related seminars, conferences, conventions, and other similar education events.
However, general property improvements, such as renovations or new furnishings, cannot generally be taken as deductions in the year they are incurred. Instead, these must be depreciated over the regular life of the property.
4. Utilizing Real Estate Taxes Losses to Your Advantage
While investors generally want their properties to make as much money as possible, if you incur losses on a commercial real estate investment, you may be able to take them as a tax deduction. However, this varies based on several factors. In general, there are three different taxpayer classifications when it comes to rental losses from commercial real estate.
Commercial real estate investors making less than or equal to $100,000 a year: These individuals can take a loss of up to $25,000 against their income. So, for instance, if an investor earned $90,000 a year and had a loss of $25,000 or more, they could reduce that year’s taxable income to $65,000. Those making more than $100,000 and up to $150,000 can take some deductions, but not nearly as much as those making less than $100,000.
Commercial real estate investors making more than $150,000 a year: Cannot take any commercial real estate loss-related deductions.
Commercial real estate professionals: If you are considered a designated commercial real estate professional by the IRS, there is no limit to the amount of real estate losses you can take in one year. To qualify, an individual needs to work a minimum of 750 hours per year in a real estate related position, such as a property manager, broker, agent, or investor. They must also generally work in this position for more hours than any other job they have.
Due to the tax benefits of being a real estate professional, some investors decide to quit their full-time jobs to pursue full time property management and investment, especially if their rental income is high enough to exceed their annual expenses. In other cases, they may have a spouse become a full-time property manager for their investments in order to take advantage of these loss deductions.
5. Reduced Tax Burdens for Beneficiaries
Commercial real estate doesn’t only have tax benefits for owners– it can also have significant tax advantages for an owner’s heirs. For instance, if an investor buys a commercial property for $3 million, and its value increases to $4.5 million before the investor passes away, the investor’s beneficiaries will only need to pay taxes on the $1.5 million that the property has appreciated, not the entire $4.5 million sale price. This can save an investor’s heirs hundreds of thousands or even millions of dollars.
6. Tax Benefits of Commercial Real Estate vs. IRAs for Retirement
Unlike IRAs, which are taxed at an investor’s regular personal tax rate when funds are withdrawn, when a borrower sells commercial real estate, they will pay capital gains taxes, which are generally much less than personal income taxes– at least for most investors. However, it should be noted that this is not the case for Roth IRAs.
7. Qualified Business Income (QBI) Deductions
The Qualified Business Income (QBI) deductions is another, somewhat complex deduction that commercial real estate investors may be able to take against their income taxes. The QBI deduction includes income from passive sources, and permits eligible individuals to deduct 20% of qualifying income. However, determining how much can be deducted is somewhat difficult.
Certain limitations include the greater of 50% of W-2 wages paid or, 25% of W-2 wages paid plus 2.5% of the depreciable basis of the property in question. In most cases, the second calculation is used, due to the fact that the majority of CRE investments are held in SPEs with few (or no) employees. It should also be noted that capital gains income from the sale of a commercial property does not count as eligible income for the QBI deduction.