If you want to sell your commercial income property, you’ve got to calculate your accurate tax basis. This move helps you avoid increased capital gains tax whenever the property is sold. It is also crucial to ascertain the tax before selling because it is crucial for figuring out property depreciation.
We will discuss the details of the tax basis, which is also known as the cost basis on Commercial Real Estate. You will learn how to calculate it and what it means for your real estate investment. First, what is Tax Basis?
Tax Basis refers to the cost of a property paid in cash with its debt obligation, and it is derived by totaling settlement and closing costs to the property’s purchase price.
The IRS has a list of costs that should be included when calculating your tax basis, and it includes:
Owner’s title insurance
Transfer taxes
Surveys
Recording fees
Legal fees
Costs of installing utility
Abstract fees
Any additional amount owed by the seller that you agree to pay (this can be back taxes, interests, or even mortgage fees)
When calculating your tax basis, you don’t have to include the following costs:
Loan assumption fee
Mortgage insurance premiums
Prices of all appraisals the lender requires
Mortgage financing fees
The tax basis of your property investment can go up or down: this depends on several factors. At the same time, capital improvements boost the tax basis while depreciation drops the cost basis. A lack of appropriate tax basis planning will make you pay double taxes.
The IRS also allows Commercial Real Estate investors to subtract depreciation from a CRE building, but this doesn’t include land as an undervalue asset. Although there are advantages to depreciation rebates when you have an investment building, the deductions will lead to increased capital gains tax when your building is sold.
For instance, if the sold property’s value is more significant than its depreciated worth, you must pay additional depreciation “recapture tax.” The recapture tax is 25% higher than the regular capital gains, which would have been at 15-23.8%. If you intend to sell the property, you must be mindful of preparing for the recapture taxes.
A commercial real estate investment property is a big deal with taxes and especially tax basis, so here is a quick, helpful tip. After purchasing the investment property, ensure to safely keep all documents recording repairs, replacements, and improvements done on the property.
You will require these records to calculate the annual cost basis and depreciation. Since you know that the expenses classified as capital repairs may be complex, you should consult a tax professional or an accountant to be specific.
4-step approach to calculate cost basis
Step one
Start by calculating the closing costs that pertain to the CRE property purchase and add this number to the original purchase price.
Step two
Subtract lender fees, mortgage insurance premiums, and loan assumption costs from the number you got above. The IRS doesn’t require these to be included as settlement costs.
Step three
Calculate the total amount spent on capital enhancements which, according to the IRS, refers to improvements that increased the property’s value. Some examples include replacing a roof or interior renovations.
Step four
Subtract the amount of depreciation that was claimed on the income property.
An understanding of the tax basis can save you thousands of dollars in capital. You’ve got to know and regulate your Commercial Real Estate property tax basis because if it is lower when you sell or foreclosure the property, you may pay higher capital gains. Regardless of your choice to sell or not, stay one step ahead of the curve by being sure of your tax basis and calculate it with your financial advisors.
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