Tax advantages are another key reason people invest in real estate. The IRS allows for many favorable real estate tax considerations including: cost recovery (depreciation), capital gains rates, pass through or “shelter” provisions, and tax deferral. Confused? I’ll keep it simple.
Cost Recovery –Uncle Sam always seems to want a piece of your income. With Real Estate, you get some breaks. If rental income less expenses shows a profit, it will be taxed. However, you are allowed an additional ‘paper expense’ called cost recovery. This additional expense will reduce your bottom line, and tax is based on the lesser amount. Cost recovery is calculated by taking the total cost of building less land, then dividing by either 39 for commercial or 29.5 for apartments.
Capital Gains – When you hold aproperty a year or more before selling, the appreciation is taxed at a capital gain rate (approximately 15%) rather than as ordinary income (say 35%). For every $100,000 in appreciation that’s $20,000 in savings.
Pass Through – If real estate is held in a LLC, S-Corp., Partnership, or individually, the annual net profit (loss) is passed through to an individual tax return. Should there be a loss, this can off set other income earned. This is often referred to as Tax Shelter.
Tax Deferral – Basically, the IRS allows you to pay taxes now, or later. Many investors choose to pay later. Transactions are carefully structured so that when property is sold, the money is quickly reinvested in another property. This eliminates the need to pay current capital gains or recapture taxes. These transactions are called “Tax Free Exchanges”. Okay, I promised to keep it simple and could continue on with many more tax advantages to owning Commercial Real Estate. Please ask your tax accountant about these, and additional tax benefits. When estimating total return on Commercial Real Estate investment, don’t forget the tax advantages