The Complete Guide to Determining Tax Basis on Commercial Real Estate

Are you thinking of selling a commercial income property? If so, it is important to calculate the correct tax basis to avoid higher capital gains tax when the property is sold. It is also necessary to determine the tax basis before you sell since the tax basis plays a role in determining depreciation.

In this blog, we’ll discuss the ins-and-outs of tax basis, also known as cost basis, then move on to how to calculate it, and finally, what it might mean to your bottom line.

What is Tax Basis?

Tax basis is the cost of the property paid in cash plus debt obligations or other property. It is determined by adding settlement and closing costs to the purchase price of the property.

According to the IRS, the following costs can be included when calculating tax basis:

• Abstract fees (abstract of title fees)
• Charges for installing utility services
• Legal fees (including title search and preparation of the sales contract and deed)
• Recording Fees
• Surveys
• Transfer taxes
• Owner’s title insurance
• Any amount the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

On the contrary, the following costs cannot be included when calculating tax basis:

• Casualty insurance premiums
• Rent for occupancy of the property before closing
• Charges for utilities or other services related to occupancy of the property before closing
• Charges connected with getting a loan. The following are examples of these charges:

1. Points (discount points, loan origination fees)
2. Mortgage insurance premiums
3. Loan assumption fees
4. Cost of a credit report
5. Fees for an appraisal required by a lender
6. Fees for refinancing a mortgage.
7.  

The basis of your investment property can either go up or down, depending on various factors. Thus capital improvements increase the basis, while depreciation decreases the cost basis.

Without proper tax basis planning, you will end up paying double taxes …

Once for the adjusted basis minus the depreciation claimed while you owned the property, and a second time for the 25% depreciation recapture tax, which is the difference between the property’s depreciated value and its adjusted basis.

Depreciation in Relation to Tax Basis

The IRS allows CRE investors to deduct depreciation from a commercial real estate building, as well as any capital improvements made, but it does not include land as a depreciable asset. While there are benefits to depreciation deductions while you own an investment property, these deductions will result in a higher capital gains tax when the property is sold.

For example, if the value of the sold property is higher than its depreciated value, you will have to pay further depreciation recapture taxes (which is 25%, a bit higher than the usual capital gains tax which is 15–23.8%). In the case of a sale, you will have to be very mindful of planning the recapture taxes.

1031 Exchanges & Tax Basis

The benefit of the IRS’s 1031 exchange code is clear here, as it allows you to defer capital gains tax through a properly structured exchange. Capital gains taxes range from 15% – 23.8%, depending on your tax bracket.

When selling an investment property and buying another with a 1031 exchange, the basis of the old property is transferred to the new property. For example, if the original property was sold for $2,500,000 with an adjusted cost basis of $750,000, then $750,000 would be carried forward to the new property.

If the purchase price of the replacement property was $3,000,000, then your adjusted basis would now be the original cost basis ($750,000) plus the difference in price between the original property and the replacement property ($500,000).

The new tax basis is 1,250,000, and is referred to as “boot.”

Cost Basis Calculation

1. First, calculate all of the closing costs related to the purchase of the investment property. Then add that number to the original purchase price.

2. Next, deduct any lender fees, points, loan assumption fees, or mortgage insurance premiums from the above number, since the IRS does not allow them to be included as settlement costs when determining cost basis (see list above).

3. Then, calculate the amount spent on capital improvements. According to the IRS, capital improvements improve the value of the property. Examples include replacing a roof or HVAC system, adding on a wing or extending a portion of the property, or extensive interior renovations that allow you to add more tenants or increase space within a commercial property. They may also include:

• • Changing a property’s use to a different use
  • Rebuilding a property that has already “met its useful life”
  • Replacing a major part of the property
  • A repair that creates an increase in efficiency, productivity, or capacity
  • Fixing a defect or design flaw

4. Finally, deduct the amount of depreciation that was claimed on the income property.

This final amount is now your adjusted cost basis.

When it comes to owning an investment property, be sure to keep all documents that pertain to repairs, improvements, or replacements, and use these documents to calculate depreciation and cost basis on a yearly basis. However, since knowing which expenses count as capital repairs can be complex, it is best to consult your accountant or tax professional.

To Wrap It Up – Understanding Tax Basis Can Preserve Thousands of Dollars in Capital

It is very important to know and adjust the tax basis of your commercial real estate property. If it is lower when selling or foreclosing the property, you will consequently have to pay higher capital gains tax. Whether you plan to sell or not, be precise with your cost basis calculation and consult with your financial advisors. A proper calculation can provide the most wealth-preserving advantages.

 

Source: The Complete Guide to Determining Tax Basis on Commercial Real Estate

https://www.creconsult.net/market-trends/the-complete-guide-to-determining-tax-basis-on-commercial-real-estate/

What is an Estimated Net Proceeds Sheet and How is this Important to Estimate Capital Gains Tax Exposure

A seller's net proceeds sheet is a document that estimates the amount of money a seller will receive after all closing costs have been paid. The amount of the net proceeds will vary depending on the purchase price of the property, the seller's existing mortgage balance, the amount of real estate taxes due, and other closing costs.

The following factors affect the net proceeds of a sale:

• Purchase price: The higher the purchase price, the higher the net proceeds.
• Mortgage balance: The lower the mortgage balance, the higher the net proceeds.
• Closing costs: Closing costs can vary depending on the state and the type of transaction.
• Other expenses: Other expenses, such as real estate taxes and home warranty fees, can also reduce the net proceeds.

The net proceeds of a sale are important to capital gains tax exposure because they determine the amount of profit that is subject to tax. The seller's taxable gain is calculated by subtracting the adjusted basis of the property from the net proceeds. The adjusted basis is the original purchase price of the property plus the cost of any improvements that have been made.

For example, if a seller sells a property for $500,000 and has an adjusted basis of $300,000, then the seller's taxable gain is $200,000. The seller will owe capital gains tax on this amount.

The amount of capital gains tax that a seller owes will depend on the seller's income tax bracket and the length of time that the property was held. For example, a seller in the 22% income tax bracket who held the property for less than one year will owe a capital gains tax of 22% on the $200,000 gain.

Selling a property can be a profitable transaction, but it is important to understand the factors that affect the net proceeds and how this can impact your capital gains tax exposure. By understanding these factors, you can make informed decisions about when to sell your property and how to minimize your tax liability.

Here are some tips for sellers to minimize their capital gains tax exposure:

• Hold the property for at least one year: If you hold the property for at least one year, you will be taxed at the long-term capital gains rate, which is typically lower than the short-term capital gains rate.
• Make improvements to the property: Any improvements that you make to the property can increase the adjusted basis, which will reduce your taxable gain.
• Donate the property to charity: If you donate the property to charity, you may be able to claim a charitable deduction, which can offset your taxable gain.

By following these tips, you can minimize your capital gains tax exposure and keep more of the money you earn from selling your property.

https://www.creconsult.net/market-trends/what-is-an-estimated-net-proceeds-sheet-and-how-is-this-important-to-estimate-capital-gains-tax-exposure/

The Problem Multifamily Can No Longer Ignore: Renters Insurance Compliance

The risks and costs of ignoring renters insurance compliance are far too great to not have the attention of rental housing providers.

Many renters live without renters insurance – all operators know it happens. Whether a renter cancels a policy, lets it lapse or forgets to renew, renters insurance compliance has remained a major challenge for operators. Renters insurance is not only difficult and time-consuming to monitor, but it also has massive effects on property insurance expenses for operators. Renters insurance compliance is a problem that multifamily can no longer ignore – the risks and costs are far too great to let it continue slipping through the cracks.

There are numerous obstacles for operators when it comes to tracking renters insurance, from confirming the authenticity of insurance documentation and tracking valid coverage to knowing exactly which renters don’t have policies and the moment a policy isn’t valid.

“The hardest part is that while it’s a requirement to have renters insurance to move-in, it’s really difficult to keep track of who remains in compliance and who doesn’t after they move in,” says Mike

Hogentogler, Chief Operating Officer of LCOR, a fully integrated real estate investment, development and management firm. “If an event occurs where an insurance claim needs to be made, we’re left wondering if the resident has coverage or if we will be responsible in any way. There is a lot of uncertainty when it comes to renters insurance, and it’s the type of uncertainty that carries a lot of risk and can get expensive.”

Compliance tracking

Operators who want to check renters insurance policies at a community have to perform random insurance audits. A renter may cancel their policy at any given time, but the only way to truly know is through the audit, and these aren’t feasible every day, let alone every week. Typically, the audits are up to the onsite team, but onsite teams already have their hands full and rarely have time or bandwidth to regularly track insurance. The audits are time-consuming and tedious, and many times these audits are far and few between.

“We’ve always trusted that residents are maintaining a policy, but the compliance tracking process needs to go beyond that,” Hogentogler says. “We need to trust, but verify. There has always been this gray area between the insured resident, insurance provider and the operator. In order to effectively track insurance compliance and really stay on top of it, it’s crucial to close that loop.”

Overarching risks

When residents don’t have renters insurance, it affects the entire community. Should something happen with a resident that is covered under the liability policy, but they don’t have renters insurance, it goes onto the community’s property insurance. As far as expenses go, operators allocate the largest amounts to taxes and insurance. If insurance rates go up, other residents eventually will have to absorb that.

“I want to do everything I can to keep my property insurance as clean as possible so I can get the most favorable rate,” Hogentogler says. “If a resident doesn’t have renters insurance for a problem, it needs to go onto my property insurance, which is now subject to deductibles and also hits my track record. Valid renters insurance policies keep my claims lower on the insurance side and give me a cleaner record so that when I go for renewal, I can push for a lower property rate to make my buildings run more efficiently.”

While there may be some bad actors who are just trying to move in and get by until they can cancel their policy, but most of the time, it’s an honest renewal oversight on behalf of the resident and the policy lapses. It could be something as innocent as a resident signing a 14-month lease, but they only had a 12-month policy and forgot to renew it.

Enter insurance techology (InsurTech) organizations

This is the gray area where InsurTech companies are stepping in to close the loop between residents, insurance providers and operators. Third-party InsurTech providers can do an initial insurance audit in a community so operators can identify which residents must return to compliance and validate policies for new residents. After that, InsurTech providers will take on the tracking process and continue monitoring renters insurance policies in real-time so operators will quickly know if any policies lapse or are canceled.

“Utilizing InsurTech or a third-party provider gives us tremendous comfort in knowing that now we can stay on top of policies in our communities and have the ability to immediately know when a resident falls out of compliance,” Hogentogler said. “Should a resident fall out of compliance, an onsite associate can contact them for documentation of a new policy or let them know we will put one in place for them.”

InsurTech services give operators confidence knowing that they’ve got the right risk mitigation strategies in place and that their most valuable assets are protected should anything happen. But it also provides a higher caliber experience for residents. InsurTech companies provide an easy way for renters to purchase insurance when they are signing a lease. Operators want to provide an exceptional level of customer service at their communities that enhances the resident experience and supplying a way to both purchase and monitor insurance is an extension of that.

“We are hyper-focused on the renter experience and want the insurance process to be as simple and seamless as possible” Hogentogler said. “InsurTech services have mastered how to use technology to allow residents to quickly and easily purchase a customized insurance policy, and also how to integrate that seamlessly into our risk mitigation.”

It’s important for operators to heed risks when it comes to renters insurance compliance, as compliance problems impact both operators and residents and increases costs. While technology has alleviated many pain points for operators, onsite teams and renters alike, it’s now trickling into the insurance arena and creating better processes for purchasing, validating and monitoring compliance and providing more robust risk mitigation tactics.

 

Source: The Problem Multifamily Can No Longer Ignore: Renters Insurance Compliance 

https://www.creconsult.net/market-trends/the-problem-multifamily-can-no-longer-ignore-renters-insurance-compliance/

Airbnb, Landlords Working Together To Fill Apartments With New Program

Airbnb rolled out a listing service for apartments that will include buildings where short-term sublets are allowed. Landlords who partner with the service will get a cut of the total booking revenue, usually 20%.

So far, the service offers apartments for short-term occupancy in more than 175 buildings managed by a dozen major apartment landlords in more than 25 markets, including Equity Residential and Greystar Real Estate Partners, The Wall Street Journal reports.

The service is an effort by Airbnb to increase the number of apartments it can offer for short-term rental, which was down 4.9% in October compared with 2019, according to peer-to-peer data specialist AirDNA. Over the same period, the number of total Airbnb listings was up 22.9%.

Airbnb bills the new service as a way for apartment renters to deal with inflation.

"As the cost of living continues to rise, renters can use the extra income earned by hosting part-time on Airbnb to contribute to their rent, save for a home, or pay for other living expenses,” Airbnb co-founder Nathan Blecharzyck, said in a statement.

The new service isn't the only step Airbnb has taken lately to shore up its business.

Earlier this month, the San Francisco-based company said it will increase the amount of liability coverage for hosts to as much as $3M, to better attract owners of houses in high-cost markets, ABC News reports. Airbnb also promised to make hidden cleaning fees — a major complaint among renters — more transparent.

.

 

Source: Airbnb, Landlords Working Together To Fill Apartments With New Program

https://www.creconsult.net/market-trends/airbnb-landlords-working-together-to-fill-apartments-with-new-program/

The Dangers of Selling Commercial Property Too Late

The last downturn

cost those who chose to sell commercial property an average of

30.3% of their property value

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Reason #1

Why people sell commercial property too late:

Complacency

 

Complacency is the most dangerous state to ignore.

It’s the moment before the market corrects and values decline. When the market goes through this initial correction, our natural tendency is to be complacent because initial corrections actually look like a cool-off period.

Then we expect the market to pick up again and continue with its growth phase.

But, the market continues to deteriorate and worries creep in as we wonder what is going on. Next, it is normal to say to yourself that your investments are good ones that they’ll ultimately come back.

When the market continues to soften until it seems there is no hope in coming back, that’s the absolute bottom of the market and the worst time to sell.

 

This point of capitulation is one of surrender and of asking how the government could let something like this happen.

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Reason #2

Why people sell commercial property too late:

Ownership and Identity

 

In order to avoid loss, people will overvalue what they own.

That is what Richard Taylor, Daniel Kahneman, and Jack L. Knetsch identified with the Endowment Effect. In fact, Kahneman and Knetsch won the Nobel Peace Prize for their research in this area of behavioral economics.

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It’s normal for people to overvalue what they own.

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In a study with Cornell undergrads, broken into groups and given identical coffee cups, Kahneman and Knetsch told one group to value the cups they owned and the other group to value the cups they would purchase.

They found the undergrads with the coffee cups were unwilling to sell their coffee cups for less than $5.25 while their less fortunate peers were unwilling to pay more than $2.25 to $2.75.

But, it was Carey Morewedge’s research into the Endowment Effect that revealed that it’s not loss aversion that leads to overvaluation, it’s ownership and identity.

Morewedge found that it’s our sense of possession that creates the feeling of an object being mine, which then becomes a part of our identity.

 

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Reason #3

Why people sell commercial property too late:

Loss Aversion

 

Why is it so difficult to sell commercial property in a market decline?

According to Brafman and Brafman, authors of Sway: The Irresistible Pull of Irrational Behavior people will go to great lengths to avoid perceived losses.

What’s more, people also succumb to their will to recover what once was.  They will spend whatever it takes not to lose, be it time, money, or emotional resources.

Imagine watching someone playing craps in Las Vegas. When they are on a roll, taking in their winnings, they race through the growth phase, reaching the peak of the game.

They feel ecstatic.

But what happens when the tide turns and they start to lose?

They enter the complacency stage, call it a short turn of bad luck, and keep playing.  They believe they will return to the top. But their bad luck continues.

By waiting to avoid losses, people hold off and then sell at the wrong time — maximizing their losses.

 

They lose their winnings, keep playing and generate losses. They would rather hold onto the idea of getting back to where they were at almost any cost than realizing their loss and moving on to another opportunity.

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Reason #4

Why people sell commercial property too late:

Self Reliance Time Traps

Time Trap #1: Self-Education

 

People will self educate online because it is free and immediately available. A review of the search term on Google for “commercial real estate trends” returned 152 million results. A search for “commercial real estate trends YouTube” turned up 310 million results!

No doubt, an abundance of free information in the form of market data, blogs, market reports, and online opinions on what’s happening in the market is available.

Time Trap #2: Friends, Family, and Non-Commercial Advisors

 

When we aren’t sure what to do, we often consult friends, family, and non-commercial real estate advisors for input. Unfortunately, these people will not want to be the ones to say sell because it is easier to say no and risk being wrong than to say yes and risk not being right.

Plus, most of these folks will not have the data that you have seen here. These people are more likely to share anecdote based advice like “My friend made a killing in real estate. You should hold on, it will come back.” Remember, people who made this mistake lost in 2008-2010.

Time Trap #3: Hire a Traditional Broker

 

It is easy to find a traditional broker, given that 1 in 164 people in the United States today have a real estate license. According to the National Association of Realtors, there are about 2 million active real estate licensees in the United States.

The problem is that most traditional brokers do not specialize in Commercial Real Estate, Investment Sales and further specialization by property type. 

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eXp Commercial Chicago Multifamily Brokerage focuses on listing and selling multifamily properties throughout the Chicago Area and Suburbs.

We don’t just market properties; we make a market for each property we represent. Each offering is thoroughly underwritten, aggressively priced, and accompanied by loan quotes to expedite the sales process. We leverage our broad national marketing platform syndicating to the top CRE Listing Sites for maximum exposure combined with an orchestrated competitive bidding process that yields higher sales prices for your property.

 

 

https://www.creconsult.net/market-trends/the-dangers-of-selling-commercial-property-too-late/

Commercial Rate Snapshot 12-5-2022

Commercial Rate Snapshot 12-5-2022

These are the average available rates from eXp Commercial's Capital Partner CommLoan database of 700+ commercial lenders as of 12/05/22 and are provided for comparison purposes only. Actual rates are dependent on property and sponsor.

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