In today’s economy it is essential for commercial real estate professionals to be aware of tax planning opportunities and the potential cash savings available to their companies. The following five tax tips may help real estate owners and developers effectively manage their tax burdens.
1. Color Your Building Green.
Whenever possible, take advantage of special deductions and tax credits for environmentally friendly features. Owners may be able to deduct the cost of energy-efficient improvements that are installed in part of the interior lighting system, heating, ventilating, and air-conditioning system, hot water system, or building envelope. The property must be placed in service by Dec. 31, 2013, and must reduce the total annual energy costs associated with interior lighting, HVAC, and hot water systems of the building by 50 percent or more.
For example, Company X, a commercial real estate developer, completes a 60,000 square foot building in 2009 that includes energy-efficient interior lighting, HVAC, and hot water systems. The cost of the energy-efficient improvements is $55,000. Company X may be able to take a credit for the lesser of the costs of the improvements or the square feet x $1.80 on its 2009 federal tax return.
2. Take Full Advantage of Depreciation.
Has your company recently undertaken new construction projects, expansions, or renovations? A cost-segregation study on the property could result in substantial long-term savings. Cost-segregation studies categorize assets into the most appropriate and tax-advantaged depreciable lives. Cost-segregation studies determine if an asset is a structural component of the building (often with a 39-year tax life) or personal property (generally a five- or seven-year tax life).
The American Recovery and Reinvestment Tax Act of 2009 also extended bonus depreciation to qualifying assets that are placed in service in 2009 and long-lived property placed in service through 2010 with respect to the costs incurred in 2008 and 2009. Qualifying property generally includes new assets with a life of 20 years or less, including qualified leasehold improvements.
Your company also may want to consider electing out of bonus depreciation. This may be beneficial if you have expiring net operating losses. Corporate taxpayers are allowed to make an election to forego bonus depreciation in exchange for the acceleration and allowance of certain unused credits, including alternative minimum tax credits and research and development credits.
3. Consider the Tax Impact of Charitable Land Contributions.
Has your company thought about contributing land to a county, city, or state? Before contributing property, examine the alternative viewpoints the Internal Revenue Service could take with regard to your charitable motives. If the IRS can successfully establish that you received a benefit for the charitable contribution, your deduction may be limited or fully disallowed.
For example, if your company contributes land to a county and also receives a zoning permit from that county to build a shopping center, the IRS could view this as your company receiving a benefit for the contribution. The charitable contribution may be required to be permanently capitalized to land or depreciated over the asset life.
Another example would be if your company contributed land to a state for a state-maintained road. If your company is not directly benefiting from the road and you can argue that the road is for “exclusive public use” then the contribution may be fully allowed.
4. Determine if You Are a Dealer or Investor.
Do you know your status as either a dealer or an investor for tax purposes? Generally, ordinary income or loss is generated when a dealer sells property and capital gain or loss is generated when an investor sells property. Advance planning can ensure the desired treatment upon disposal of your property. The test for the determination of dealer versus investor is subjective; therefore, you should document your facts and specific circumstances carefully to support your position.
Three questions that should be answered in determining your dealer or investor status are: what is your business; did you hold the property primarily for sale in your business; and were the sales ordinary in your business?
Do not assume, especially in today’s economy, that it is in your best interest to be an investor instead of a dealer. If you sell property today for a loss and you are considered to be a dealer, then you will be allowed to recognize the loss as ordinary and offset any other ordinary income. However, if you are an investor, the loss would be capital and only allowed to offset capital gains and up to $3,000 of ordinary income.
5. Allocate Land Cost to Your Benefit.
When a developer purchases a tract of land with the intention of developing and selling the parcels over time, the cost of the land must be allocated to each parcel. The IRS requires that the cost be “equitable apportioned.” However, there is very little guidance on how to do so.
With appropriate tax planning and consideration, the developer may be able to defer income upon the sale of the land parcels. However, the taxpayer cannot defer the gain until all of the property is sold, but must recognize it as each parcel is disposed of. A taxpayer should be cautious in choosing a method without tax planning, as this may be considered an accounting method and only can be changed by obtaining IRS approval.
Current and future land improvement costs also should be considered when allocating the cost among land parcels. Future costs even may be incurred after several of the parcels are sold; however, those parcels still can benefit from the improvement and therefore should be allocated an estimated cost.
There are many tax saving ideas and strategies that can be maximized if careful planning and consideration is taken in advance. Be sure to take advantage of those tax benefits and be cautious in choosing accounting methods to ensure that your company is minimizing its tax liability. Consult a qualified tax adviser to discuss tax strategies in detail and to determine if they are relevant to your company.