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/

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Here's who qualifies for 0% capital gains taxes for 2023

How to calculate your capital gains tax bracket

With higher standard deductions and income thresholds for capital gains, it's more likely you'll fall into the 0% bracket in 2023, Lucas said.

For 2023, you may qualify for the 0% long-term capital gains rate with taxable income of $44,625 or less for single filers and $89,250 or less for married couples filing jointly.

The rates use "taxable income," which is calculated by subtracting the greater of the standard or itemized deductions from your adjusted gross income.

For example, if a married couple makes $100,000 together in 2023, their taxable income may easily fall below $89,250 after subtracting the $27,700 married filing jointly standard deduction.

By comparison, you may have been in the 0% long-term capital gains bracket for 2022 with a taxable income of $41,675 or less for single filers and $83,350 or less for married couples filing jointly.

Other tax-planning opportunities

With taxable income below the thresholds, you can sell profitable assets without tax consequences. For some investors, selling may be a chance to diversify amid market volatility, Lucas said.

"It's there, it's available and it's a really good tax-planning opportunity," he added.

Whether you're taking gains or tax-loss harvesting, which uses losses to offset profits, "you really have to have a handle on your entire reportable picture," said Jim Guarino, a CFP, certified public accountant and managing director at Baker Newman Noyes in Woburn, Massachusetts.

That includes estimating year-end mutual fund payouts in taxable accounts — which many investors don't expect — and may cause a surprise tax bill, he said.

"Some additional loss harvesting might make a lot of sense if you've got that additional capital gain that's coming down the road," Guarino said.

Of course, the decision hinges on your taxable income, including payouts, since you won't have taxable gains in the 0% capital gains bracket.

 

 

Source: Here’s who qualifies for 0% capital gains taxes for 2023

https://www.creconsult.net/market-trends/heres-who-qualifies-for-0-capital-gains-taxes-for-2023/

SBA 504 Commercial Real Estate Loans

SBA 504 Loan Features

Through the 504 Loan, 40% of the total project costs must come from the SBA. 50% of the total project costs come from the participating lender. Borrowers of 504 loans contribute a further 10% of the project costs, but in rare circumstances, the borrower may be required to contribute 20% of project costs.

504 loans have fixed-rate interest rates, long loan amortization, and no balloon payments. Compared to other loans, 504 loans offer savings that result in improved cash flow. The maximum loan amount is $5 million, or $5.5 million for small manufacturers or certain types of energy projects.

For every $65,000 borrowed, businesses must make one job or retain one job. The exception to this is small manufacturers. These businesses are held to a ratio of one job for every $100,000. Businesses that will not create or retain jobs may still borrow an SBA 504 loan under certain circumstances, as long as the CDC maintains acceptable job creation or retention overall.

Who Is Eligible For The Loan Program?

Businesses must be for-profit entities and must be the correct size according to the SBA.

Businesses with a tangible net worth of over $15 million are not eligible. An average net income at or below $5 million after federal income taxes is also required. Businesses must have this average net income for the two years just before application. Nonprofit organizations and businesses engaged in passive or speculative activities do not qualify for the 504 loans. CDCs can help businesses in their geographic region determine whether they qualify.

What Type Of Commercial Properties Is An SBA 504 Loans Well-Suited for?

Businesses can finance almost any type of commercial property as long as its owner-occupied and are part of their business.

What can an SBA 504 loan be used for?

For a $1,000,000 activity, 504 project costs may be used for the following activities:

Buying land

Purchase of a building

Renovation of an existing building

Purchase of furniture and equipment

Soft costs

Proceeds from 504 loans must be used for fixed assets and some soft costs.

Land improvements (such as grading, utilities, street improvements, landscaping and parking lots)

New building construction

Long-term machinery

Modernization of an existing building

Conversion of an existing building

Debt refinancing in connection with business expansion through construction of new facilities, purchasing of new equipment, or renovation of existing facilities

It's important to note that the SBA 504 program cannot be used for purposes relating to inventory or working capital, consolidation of debt, or repayment of the debt, except for projects as described above.

Amortization

SBA 504 loans are amortized over 10, 20, or 25 years. Borrowers can work with their CDC and lender to determine which repayment schedule works for them.

Collateral Required For SBA 504

Project assets are used as collateral. Personal guarantees may also be required.

Available Interest Rates

SBA 504 loan rates correlate to the current market rate for 10-year and 5-year U.S. Treasury issues. 20 and 10-year loan maturities are available.

Can You Refinance An SBA 504 Loan?

No, you can't refinance an SBA 504 loan. However, there is a 504 refinancing program offered by the SBA, which allows business owners to refinance an existing commercial loan. The loan being refinanced cannot be any type of SBA loan.

85% of the original business loan should match the qualifications for an SBA 504 loan, and the remaining 15% of the loan must have been used to benefit the company. The original loan must be no less than two years old. To refinance, borrowers must make a 15% down payment, and eligible assets must be used as collateral.

Businesses less than two years old are not eligible to refinance. Businesses cannot refinance to expand their business, although they muse a standard 504 loan to promote their own business growth. Getting a 504 refinancing loan is a very similar process to getting a 504 loan. To start, the business must work with a CDC and private lender to obtain the loan

 

 

Source: SBA 504 Commercial Real Estate Loans

https://www.creconsult.net/market-trends/sba-504-commercial-real-estate-loans/

Should I Sell or Should I Hold? When is the best time for asset repositioning?

When it comes to selling their investment properties, clients typically ask me,’ Why should I sell?’ Great question. Why should you sell? The obvious answer is that you purchased the investment property as an investment, and it may not be doing as well as other investment opportunities, and after a while, you don’t realize the appreciation and thus maximization of profit from the property until you sell and acquire another investment property. So the question is really, ‘When should I sell? Clients really lose the perspective of the driving reason why they invested in an investment property in the first place. An investment property is just that; an investment. Treated as such, every investment must have a horizon and an exit strategy. If a property was purchased as an investment, then it makes full sense to profit as much as possible from the investment.

The real estate market, like any other market, will go through peaks and valleys. Trying to predict the exact moment of peak or the exact moment the market reaches the bottom is practically impossible. The real estate cycle has four phases; recovery, expansion, hyper supply, and recession. The complete real estate market cycle seems to have an average duration of about 18 years as there is good historical data to support that. So, where are we in that cycle now? How much more upside will we see before we reach the peak? The question really is, ‘What is your appetite for risk?’

Below is a chart of the real estate cycles dating back from the 1800s. The last real estate market crash started at 2006. We are almost 16 years into that cycle. Interest rates are still at all-time lows. Money is cheap, and the threat of inflation is very high. How long can government print money without paying the price down the road? How much road do we have left?

So when is a good time to exit an investment property? As with everything else, real estate is cyclical. Those of us that have been around for some time have witnessed several cycles in the real estate market. Since it is practically impossible to predict the peak of cycles, what strategy should you then use to maximize your investments? Keeping it simple, when evaluating if you should consider selling an investment property, it doesn’t really matter what the current real estate market is like. If you are looking to replace the investment property with another investment property, the ultimate decision to sell should also be based upon if you can increase your returns with the new replacement property, not what state the current market is in now.

There are a number of factors that can impact real estate prices; availability, investment potential, and interest rates, to name a few. Interest rates impact the price and demand of real estate—lower rates bring in more buyers due to the lower cost of money but also expand the demand for real estate, which can then drive up prices. As interests rate starts to inch up, the cost of money increases, and thus the appetite for real estate investments declines.

However, there are many ways that one can still protect their investments. 1031 Exchanges give investors a vehicle to reposition assets and mitigate risk. There are certain asset classes that inherently hold less risk and still perform as an investment vehicle. The questions really come down to; ‘How long do I hold on during this cycle? Do I have the time horizon to outlast another cycle? Is it time to reposition and take advantage of 1031?

As part of the team for our client’s investments, we specialize in building solutions around our client’s needs. We analyze the requirements, crunch the data, and present assets entirely based on their circumstances and the goals they are trying to achieve with their investment.

Have you thought of selling your property and would like to know what it’s worth? Request a valuation for your property below:

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Source: Should I Sell or Should I Hold? When is the best time for asset repositioning?

https://www.creconsult.net/market-trends/should-i-sell-or-should-i-hold-when-is-the-best-time-for-asset-repositioning/