Commercial property owners are always on the lookout for ways to reduce tax costs and enhance profitability. By employing the right tax planning strategy, you can increase cash flow and boost profitability efficiently and legally. The following is a brief overview of some tools you can use to achieve your business goals.
Obtain the Real Estate Professional Designation
According to U.S. tax laws, losses from a passive activity can only be used to offset income from a passive activity. If passive losses exceed the passive income in a tax year, they will be carried forward to the succeeding year. Rental activity is considered a passive activity by the IRS.
The IRS defines a real estate professional as someone who spends at least 750 hours doing actual property trades or participating materially in real property businesses during a tax year. Also, to be considered a real estate professional, more than half of the services an individual performs should involve property trades or other real estate activities.
If you have the real estate professional designation, a rental activity is no longer considered “passive.” You can deduct up to 100% of your rental losses against other types of income, such as your wages. For instance, you have a combined net income of $125,000 from your rental property and your wage income. Your net losses from your rental property can reach up to $80,000. You can offset your income with your losses and lower your adjusted gross income (AGI) to $45,000. Meanwhile, a person without a real estate professional designation would still have a taxable income of $125,000.
Bonus Depreciation and Cost Segregation
Bonus depreciation is a tax incentive that allows business owners to deduct a large percentage of the cost of certain assets in the year they were acquired, as opposed to the deduction being spread out over several years. This change in the tax law allows property owners to deduct up to 100% of eligible assets of a qualified investment property.
For instance, you purchase $50,000 worth of new light fixtures and appliances for your commercial property. The entire cost can be depreciated in the same year you bought these assets. Instead of deducting $10,000 annually for five or seven years, you can make a one-time deduction of $50,000.
Cost segregation is utilized by commercial property owners to improve cash flow. It works by accelerating the depreciation of eligible assets and deferring taxes to later years.
A building and associated assets depreciate at different rates. The depreciation period for commercial real estate is 39 years. On the other hand, some assets have shorter depreciation lifespans of 5, 7, and 15 years. Office furniture has a depreciation yearly.
The goal of a cost seg study is to identify and reclassify these assets into the appropriate recovery periods. It allows commercial property owners to legally write them off in the shortest amount of time possible. The benefits are reduced taxable income and improved cash flow.
Tax planning is a must for commercial property owners who wish to improve cash flow and maintain profitability. Apart from the two strategies mentioned, there are many other tools that you can use to realize significant tax benefits. A tax professional can advise you on other methods to lessen your tax burden and boost your earnings.