With the average annual ROI for commercial real estate being 9.5%, property investment remains a profitable avenue. More buyers continue to express interest in the investment. Some are turning to commercial property loans to realize this goal.
Besides helping you purchase the property, a commercial property loan offers various tax benefits. These benefits include mortgage interest deductions and accelerated depreciation, among others. When capitalized, they help increase returns over time.
But, to unlock these tax advantages, you need to know what they are and how they work.
Deduct Qualified Interest Expenses
Interest is the amount paid to a lender to borrow or delay debt repayment. The lender can roll the interest incurred in your property loans into your monthly payment. So, expect to pay back part of the borrowed amount plus interest every month.
Luckily, you can deduct various interest expenses to make a loan affordable. These expenses include interest related to income-generating activities and investment interest. The IRS also allows deductions on qualified mortgage interest.
If you have a deductible on mortgage interest, your business will pay fewer taxes over a year. The rules still apply, notwithstanding the type of collateral used to secure the loan.
The IRS expects to file Form 1098 to report qualified mortgage points and interests. You also need to include the deductions on a 1040-SR form when claiming the tax break. But, the deductions can change due to certain exclusions and limitations.
Claim Deductions on Non-Mortgage-Related Expenses
Non-mortgage-related expenses such as maintenance and repair costs are tax deductible. The IRS only allows rental property owners, businesses, and sole proprietors to deduct them from taxes. It considers them part of routine maintenance costs that help prolong the lifespan of a property.
You can deduct the expenses from your taxes in the year they occur. So, keeping records of the amounts and receipts can help you claim the deductible.
General property improvements such as new furnishings and renovations don’t qualify. Instead, they need to depreciate over the property’s regular lifespan.
Wait for the Property to Depreciate
Like any other physical asset, a commercial property can wear down over time. Whether you bought it with a loan or personal finances, you can deduct a certain amount from your income taxes. The tax deductions help account for the depreciation of the property.
According to the IRS, owners can depreciate commercial properties over a period of 39 years. They can only claim depreciation if they are the rightful owner. The condition still applies even if you are still repaying a loan taken to purchase the building.
As a property owner, you need to have the property’s legal title or duty to pay taxes. Being responsible for the risk of loss if the property diminishes in value or sustains damage also makes you an owner.
You start depreciating a commercial property when you use it to generate income. Also, you stop depreciating the building when you stop making money out of it or fully recover your costs.
Make Use of the Qualified Business Income (QBI) Deductions
QBI deductions are available to eligible small-business or self-employed owners. Eligible businesses for this incentive include LLCs, S corporations, partnerships, and sole proprietorships.
With QBI deductions, you can subtract up to 20% of the income generated from your business from taxes. If you used a commercial property loan to purchase the business premises, you could tap into this opportunity.
As of 2023, the total taxable income limit for joint filers is $364,200. The limit for single filers is $182,100. If your business is over these limits, claiming a QBI deduction is quite difficult.
Your business needs to generate “pass-through” income to qualify for QBI deductions. “Pass-through” income is the income the IRS expects you to report on your personal tax returns.
QBI excludes interest income, dividends, and capital gains or losses. It also doesn’t comprise certain guaranteed payments to shareholders/partners and income earned outside the US.
Use 1031 Exchanges to Defer Capital Gains
After purchasing a commercial property with a loan, you can defer its capital gains through the 1031 exchange. With this exchange, you can trade the property for another within a given time frame. The other property should have an equal or higher value than the original property.
You can exchange your property for a completely different one. For instance, you may trade a mixed-use building for a shopping center of the same or greater value.
Generally, you may structure the sale of your property as a 1031 sale for consolidation or management relief. Doing it may help you build a portfolio, relocate your investment to a new location or build up equity.
1031 exchanges only allow real estate investors to defer capital gains temporarily. So, expect to pay your taxes in full after selling the new property. You can also engage in another 1031 exchange after making the sale.
Develop Commercial Real Estate in Opportunity Zones
Opportunity zones are a great way to grow your investment portfolio. They comprise distressed communities (those inhabited by low-income residents).
Start a commercial real estate development in an opportunity zone to enjoy the tax benefits. You may use a commercial property loan or personal finances in this investment. Either way, you can only claim the tax benefits if the property has lasting benefits to the community.
Join the Historic Tax Credit (HTC) Program
Under the HTC program, you can earn tax benefits for rehabilitating a historical building. Only commercial-use buildings qualify for this program. For the building to qualify, it should have most of its original external walls and internal structural framework.
You can also sign a historic preservation easement (a voluntary legal agreement) to enjoy the tax benefits. The legal agreement helps protect historic properties. When you sign one, it restricts the changes made or the development of the property.
Looking for Commercial Property Loans? Apply Today!
Taking commercial property loans is a huge financial decision. On the bright side, you can enjoy certain benefits and deductions from the purchase of the property. The benefits reduce your overall tax payments and loan payments.
Turn to Merchants Mortgage for a wide range of real estate loans. The company operates with predictability and speed to meet customers’ needs. Learn more about the application process today.