Many strategies exist that can significantly reduce the tax burdens of commercial real estate business owners. From operating short-term rental properties to conducting a cost segregation analysis, there are numerous lesser-known loopholes that allow you to maximize tax deductions and reduce your overall tax liability.
Let’s take a closer look at how real estate business owners can maximize profitability and reduce their taxes:
1. Short-Term Rentals
Did you know that income generated from a rental property can be considered as not part of your annual passive income and thus be excluded from taxation? This loophole has the potential to save you thousands of dollars per year.
How? Property owners who receive rental income for the use of a dwelling may be able to deduct certain expenses, such as maintenance costs, utility bills, insurance fees, interest paid on a mortgage, real estate taxes, casualty losses, and depreciation. This will lower the amount of rental income that's taxable, as long as the short-term rental property meets a few requirements. These regulations will vary according to state and local laws, but the there are a few federal requirements that apply:
- Average customer use is 30 days or less, with personal services provided by the property owner related to property use by customers, such as catering, laundry, or cleaning services.
- Property owners are permitted to rent their properties tax-free for up to 14 days per year, as long as the owner also resides in the dwelling for at least 14 days.
2. Real Estate Professional Status
Licensed real estate professionals have fewer limitations on how they can apply property-related tax deductions. The IRS places strict limits on these deductions for unlicensed individuals, but licensed real estate professionals can use deductions to offset other sources of income. However, it’s important to remember that depreciation expenses from a certain property can only be used to offset that property’s income.
3. Cost Segregation
A cost segregation study accounts for all construction-related expenses that qualify for accelerated depreciation. Cost segregation allows taxpayers to claim construction costs and defer both federal and state income taxes on a much shorter timeline—15-, seven-, or five-year periods—than the standard 39 years for nonresidential buildings.
As part of the Tax Reform Act of 1986, cost segregation can be used by real estate businesses that have purchased, built, upgraded, or expanded their property investments.
However, these real estate costs must be related to personal property assets. This includes any money paid for improvements to the surrounding property, indirect construction costs, and items that aren’t necessary for the building’s operation and maintenance, such as furniture, home appliances, equipment, and vehicles. Land improvement deductions may include the cost of maintaining or repairing areas such as parking lots, walkways, and driveways, along with the installation, maintenance, or repair of assets such as fencing and landscaping.
4. Partial Asset Disposition
Some restorations, adaptations, and upgrades allow you to perform a partial disposition of the older property and capitalize the new, improved property. Calculating partial disposition can be completed using the following steps:
- Identify the cost of the replacement property.
- Calculate the historical price of the original property.
- Identify the change rate.
- Discount the present-day cost to its historical cost via the rate of change.
- Separate the basis and depreciation costs.
- Calculate gain or loss and get rid of the partial asset.
- Begin depreciation of the new asset.
Help Your Commercial Real Estate Business Reduce Its Tax Burden
Cost segregation can help real estate business owners to dramatically reduce their tax burdens. To understand if your property qualifies for a cost segregation analysis, contact us today!