Do you own a piece of property that you rent out? You may also be able to save on taxes by taking advantage of commercial real estate tax deductions. Whether a modest apartment or a large commercial building, investing in commercial property often gives various tax savings for a small business.
A good financial or tax advisor can help you deliberate how an investment will affect your firm, but many people use it as both a place to conduct a business and a tax-benefit-rich asset. To further understand how commercial real estate tax deductions work, read on.
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Material Participation Vs. Active Participation
Your rental property engagement will receive non-passive tax treatment if you meaningfully participate as a real estate professional. You can deduct any losses from other sources of income and avoid paying the net investment tax.
You materially participated in an activity, according to the IRS, if you meet any of the following criteria:
- During the year, you spent more than 500 hours on the activity.
- You put in at least as many hours as anyone else in the activity throughout the year.
- You materially participated in any three prior tax years, which is a personal service activity.
Active participation is a lower level of commitment than material involvement. If you “make management decisions in a meaningful and bona fide sense,” the IRS considers you are actively participating. Management decisions that count as active involvement include:
- New tenant approval
- Choosing rental terms
- Approval of expenses
You may be eligible to reduce some of your passive losses if you actively engage by making management choices and have at least a 10% interest in the investment.
This level of involvement allows for a unique passive loss rule. If your Modified Adjusted Gross Income (MAGI) amounts to $100,000 or less, you may deduct $25,000 in passive losses. The deduction is phased away if your MAGI is between $100,000 and $150,000.
You can’t suffer any passive losses after your MAGI reaches $150,000. Losses above $25,000 can be carried forward.
Types Of Rental Property Tax Deductions
You can deduct different expenses associated with purchasing, operating, and maintaining a rental property as a landlord. The most prevalent deductions are shown below.
Deduction For Mortgage Interest
Mortgage-related expenses, like commissions and appraisal costs, are not deductible when paid. These expenses are instead included in your property’s basis.
You can still deduct interest on secured mortgage debt on your first or second property up to $750,000 ($1 million if taken out before Dec. 16, 2017). Mortgage interest is deductible as a business expense for investment properties.
Depreciation Of Rental Property
Another major tax reduction is the allowance for depreciation. Depreciation allows you to deduct costs over the property’s useful life rather than a single substantial deduction when you buy (or improve) it. If your rental property fits the following criteria, the IRS will allow you to depreciate it:
- The property is under your name.
- You use the property for your business or to generate income.
- It is something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.
- You anticipate the property lasting longer than a year.
- The property was not put into operation within a year and was later disposed of (or no longer utilized for business).
Qualified Business Income (QBI) Deductions
Another more complicated deduction that commercial real estate owners may be allowed to take against their income taxes is the Qualified Business Income (QBI) deduction. The QBI deduction includes passive income and allows eligible individuals to deduct up to 20% of their qualifying income. However, calculating how much can be deducted is a challenge.
The greater of 50% of W-2 earnings earned or 25% of W-2 wages paid plus 2.5 percent of the property’s depreciable basis in question is one of the limitations. Because the bulk of CRE investments is held in SPEs with few (or no) workers, the second computation is usually employed.
Reduced Tax Burdens For Beneficiaries
Commercial real estate can present significant tax benefits to the owner and the owner’s successors. For instance, if an investor purchases a commercial property for $3 million and its value rises to $4.5 million before the investor dies.
The investor’s successors will only have to pay taxes on the $1.5 million increase in value, not the entire $4.5 million sale price. This can save the heirs of an investor hundred of thousands of dollars, if not millions of dollars.
Leave It To The Pros At Saint Investment
Professionals at Saint Investments are backed by years of investing expertise and founded by the high net-worthy investment partners. Using dependability, flexibility, and performance as basic foundations of their operational strategy, Saint Investments brings unique commercial real estate investment terms to the real estate world.
Cover all your bases with trusted professionals at Saint Investment and learn more about how to invest in income funds by scheduling a free consultation with our team today!
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.