Why Real Estate is the Foundation of Wealth Creation
March 13, 2024
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Investing in commercial real estate (CRE) has long been considered a great way to build wealth, offering steady returns and long-term growth. However, recent tax policy changes have led to a sudden increase in taxes for real estate investors, putting pressure on profits. Without the right tax strategy, these higher taxes can become a significant burden, cutting into your returns and limiting your ability to reinvest in your business.
While you can’t avoid paying taxes, there are ways to reduce the amount owed and minimize tax exposure for commercial property owners. With the right approach, taxes can even present opportunities. Effective tax planning can help you reduce your liabilities, maximize deductions, and take advantage of tactics that defer capital gains tax.
Here’s how to reduce your tax burden and secure bigger returns as an investor.
Taxes are a big part of owning CRE, and understanding them is key to maximizing your investment. You’ll deal with several types of taxes, including property taxes, federal income taxes, state and local taxes and, in some cases, rental or sales taxes. Here's how each one works.
Property taxes are probably one of your biggest recurring costs as a commercial property owner. These taxes are based on the property’s assessed value, which local tax authorities determine by looking at things like recent sales in the area, improvements you've made to the property and, sometimes, even the income it generates.
What makes property taxes important is that they fund local services like schools, roads, and infrastructure. However, they also directly impact your investment’s profitability, so it’s vital to factor them into your financial planning. Since rates and assessment methods vary from one city or state to another, it’s essential to know the specific rules in your area to avoid surprises.
Federal income taxes apply to the profits you earn from your CRE, which is essentially the income left after deducting expenses like maintenance, repairs, and property management fees. You’ll want to keep good records because every deduction helps lower your taxable income and reduce the amount you owe.
One important detail: Security deposits aren’t counted as taxable income unless you keep them to cover damages or unpaid rent. Careful tax planning and knowing the rules can make a big difference in how much you pay.
On top of federal taxes, you’ll also need to account for state and local taxes, which vary depending on where your property is located. These could include additional property taxes, state income taxes on your profits, or local business taxes. In some areas, tax rates can be quite high, so it’s essential to understand the impact on your overall returns.
One way to manage these costs is by including them in your lease agreements. Many commercial property owners pass these taxes on to their tenants as part of the lease, helping to offset the financial burden.
In certain locations, a rental or sales tax may be applied to the income you generate from leasing commercial property. This tax is typically a percentage of the rent you collect from tenants, but it can vary based on state and local laws.
Most commercial landlords handle this by building it into the rent agreement, meaning tenants are responsible for paying the tax. However, you’ll need to make sure your lease terms outline who pays what clearly, to avoid any confusion or unexpected expenses later.
When selling CRE, capital gains taxes can affect your overall returns significantly. These taxes are applied to the profit you make from the sale, and the tax rate depends on how long you've owned the property and the amount of profit gained.
The difference between short-term and long-term capital gains lies in the holding period of the property. Short-term capital gains taxes apply when a property is sold after being held for less than a year. In this case, the profit is taxed at your regular income tax rate. On the other hand, long-term capital gains taxes apply when you’ve owned the property for more than a year, and these gains are taxed at a lower rate to encourage longer-term investments.
For example, single filers with incomes below $41,675 may qualify for a zero percent long-term capital gains tax rate while the highest long-term capital gains rate can be 20%.
Knowing the difference between these two types of taxes is crucial for property investors as it helps in making informed decisions about when to sell and what the tax implications might be.
To calculate capital gains tax on a commercial property, follow these steps:
Filing Status
0% Tax Rate
15% Tax Rate
20% Tax Rate
Single
Up to $47,025
$47,026 to $518,900
Over $518,900
Married Filing Jointly
Up to $94,050
$94,051 to $583,750
Over $583,750
Head of Household
Up to $63,000
$63,001 to $551,350
Over $551,350
Reducing your tax liability is essential for maximizing returns on your CRE investments. With the right strategies, you can defer taxes and improve the profitability of your properties. Here are actionable approaches to help you achieve these goals.
A 1031 exchange is a powerful strategy that allows you to defer capital gains taxes when you sell one property and purchase another of like-kind. Here's how it works:
To get the full benefit of a 1031 exchange, you must follow strict rules, so it's essential to work with a qualified intermediary and consult a tax professional. With proper planning, this strategy helps investors reduce their tax burden and reinvest more money into growing their portfolios.
Opportunity zones are designated areas where investors can receive tax incentives for contributing to economic development. Here's why this strategy is beneficial:
To take advantage of this, you need to set up a Qualified Opportunity Fund and invest in properties located in these areas. This strategy not only offers significant tax benefits but also contributes to revitalizing communities.
Property taxes can eat into your profits, but you might be paying more than you need to. You can lower your property tax bill by:
By being proactive, you can ensure you're not paying more than necessary.
Depreciation allows property owners to deduct the cost of the property over time, reducing taxable income. Cost segregation is a more advanced strategy that accelerates depreciation for certain components of the property, leading to larger deductions upfront. This can:
Consult a tax advisor to ensure you're maximizing these deductions.
If you're looking for a hands-off way to invest in real estate while still benefiting from tax efficiencies, consider a REIT. By investing in REITs:
REITs are also eligible for special tax treatment, such as dividends being taxed at a lower rate. This strategy allows you to enjoy real estate investment returns with fewer responsibilities.
Certain real estate projects qualify for tax credits, which directly reduce the amount of tax you owe. Examples include:
These credits can lower your tax bill significantly, so it’s worth exploring if your projects meet the requirements.
A partner who knows the right strategy is essential for success in CRE. Ben Reinberg, with over 30 years of experience and a $500 million-plus portfolio, has a proven track record of helping investors thrive by providing access to exclusive opportunities and recession-resistant properties. His conservative approach focuses on net leased investments in medical, retail, industrial, and office sectors, delivering predictable cash flows and long-term appreciation. With Ben's guidance, investors have consistently achieved a 28% internal rate of return (IRR), ensuring their portfolios grow steadily even in uncertain markets.
Partnering with Ben, you’ll benefit from his deep market knowledge and expertise in structuring investments for maximum returns. He helps investors make informed decisions, from identifying the best deals to optimizing tax strategies, all while minimizing risks. With Ben by your side, you can confidently grow your wealth in CRE, knowing that your investments are in the hands of a trusted expert.
