Investing in commercial real estate can be great for building long-term wealth and diversifying your investment portfolio. However, commercial properties have complex tax implications that are important to fully understand before making your first investment. Carefully evaluating the tax expenses can help you maximize your returns. Here is a quick guide to the main commercial property taxes first-time investors should be aware of:
1. Property Tax
Property tax is levied on the assessed value of the commercial property annually by local governments. It varies quite a bit depending on location but generally ranges from 0.5% to 3% of assessed value each year. Property taxes can be substantial expenses but are deductible on your federal income taxes, which helps offset the cost. Being aware of appeal options and strategies to potentially lower your property tax bill can help manage this ongoing expense.
2. Sales Tax
Sales tax applies to all retail transactions that take place at your commercial property. The buyer pays the sales tax, but as the property owner, you are responsible for properly collecting and remitting the sales tax to the appropriate government agencies. Sales tax rates vary widely by state and municipality. When evaluating potential retail properties, be sure to carefully consider the sales tax obligations and how they may impact your bottom line.
3. Income Tax
The rental income generated by your commercial property is subject to federal and state income taxes each year. You must accurately report all rental income, properly deduct eligible expenses, and use appropriate depreciation schedules on your annual tax returns related to the property. Working closely with your certified public accountant (CPA) can help you minimize your overall income tax liability associated with your commercial real estate.
4. Capital Gains Tax
When you eventually sell your commercial property at a profit down the road, capital gains taxes will apply to the increase in value since you originally purchased it. The capital gains tax rates are typically lower than ordinary income tax rates but can still represent quite a significant expense. There are some strategic tax reduction tactics available, so be sure to consult your tax advisor or CPA to maximize your net proceeds when you sell.
5. Transfer Tax
Some states and cities charge a transfer tax when a commercial property is sold, which is based on the value of the property. The seller is responsible for paying the transfer tax, which generally ranges from 0.1% to 5% of the sales price. The transfer tax can vary greatly depending on the location of the property, so research the potential transfer tax rates in the areas you are considering investing in. Having a clear understanding of the transfer tax implications will help you accurately evaluate the profitability of investment properties and determine your net gains.
6. Cost Segregation
Cost segregation is a very strategic tax planning strategy to consider for maximizing depreciation deductions in the early years after purchasing a new commercial property. RE Cost Seg specialists work closely with your CPA to “segregate” components of the property into shorter depreciable lifetimes, increasing total depreciation deductions taken. For qualifying property owners, this can provide substantial tax savings and defer taxes.
Carefully evaluating how you will be taxed is a critical part of making smart commercial real estate purchase decisions and maximizing your long-term returns. While the various property taxes can seem complex initially, working with experienced tax professionals like a CPA and tax advisor can help you properly minimize your overall liability and keep more rental income over time. Completely understanding the impact of all commercial property taxes is essential homework for first-time investors and is a very important step that must be taken before committing to a purchase.