Common Tax Mistakes Commercial Real Estate Owners Make and How to Avoid Them

Ownership of commercial real estate provides notable tax advantages, but common errors can cause missed deductions, penalties, and increased taxes. This article highlights key mistakes, their impacts, and practical strategies to maximize tax benefits, ensuring compliance and profitability.

Common Tax Mistakes and Consequences

1. Failing to Track Expenses

Mistake: Owners often neglect to document operating expenses such as utilities, repairs, property taxes, or insurance, which leads to missing out on deductions. Poorly categorizing expenses can also cause overlooked costs like advertising or professional fees.

Consequences: Missing deductions raise taxable income. For instance, not deducting $50,000 in expenses (e.g., $20,000 utilities, $15,000 maintenance, $10,000 insurance) results in an extra $18,500 in taxes at a 37% tax rate.

Example: An owner of a retail strip mall spends $30,000 on landscaping but doesn't have receipts, so the IRS disallows the deduction, costing $11,100 in taxes.

2. Misunderstanding Depreciation

Mistake: Errors include:

• Not conducting cost segregation studies to accelerate depreciation on components like carpeting or parking lots (5–15 years vs. 39 years).

· Overlooking bonus depreciation, now 100% for qualifying assets (e.g., equipment, improvements) placed in service after January 19, 2025, per The One Big Beautiful Bill Act (OBBBA), compared to the TCJA’s phase-down (80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026)

• Misclassifying repairs as capital improvements, delaying deductions.

Consequences: A $2 million property with $400,000 reclassified via cost segregation yields $80,000 in first-year deductions vs. $51,282, saving $10,628 at 37%. Missing 100% bonus depreciation on a $500,000 renovation forfeits $185,000 in deductions ($500,000 × 37%).

Example: A warehouse owner renovates for $300,000 in 2025 but uses 39-year depreciation ($7,692 annually) instead of 100% bonus depreciation ($300,000 immediate deduction), costing $111,000 in tax savings.

3. Missing 1031 Exchange Deadlines

Mistake: Section 1031 exchanges defer capital gains taxes but require identifying replacement properties within 45 days and closing within 180 days. Errors include missing deadlines or not using a qualified intermediary (QI).

Consequences: A $1 million gain triggers $238,000 in taxes (20% capital gains + 3.8% NIIT) if deadlines are missed, reducing reinvestment funds.

Example: An owner sells an office building for a $1.5 million gain but misses the 45-day deadline, owing $357,000 in taxes.

4. Neglecting Tax Credits

Mistake: Owners often overlook credits such as:

• Section 179D: Up to $5/sq. ft. for energy-efficient upgrades.
• Historic Rehabilitation Credit: 20% of renovation costs for historic buildings.
• Opportunity Zone Benefits: Deferral and exclusion of capital gains.‍
• OBBBA’s QPP Deduction: 100% deduction for nonresidential real property essential to U.S. manufacturing, for new construction or used property acquired after January 19, 2025, and placed in service before 2031.

Consequences: Missing a $250,000 Section 179D deduction for a 50,000 sq.-ft. building costs $92,500 in taxes. A $2 million manufacturing facility misses a $2 million QPP deduction, costing $740,000.

Example: A historic building owner renovates for $2 million but misses a $400,000 Historic Rehabilitation Credit, losing out on $400,000 in savings.

5. Improper Lease Structuring

Mistake: Gross leases increase owner expenses, while triple-net (NNN) leases shift costs to tenants, reducing taxable income. Unclear lease terms lead to missed deductions.

Consequences: A gross lease with $300,000 in income and $100,000 in expenses increases out-of-pocket costs. An NNN lease could save $29,600 in taxes by reducing taxable income to $220,000.

Example: Failing to document $50,000 in tenant-paid taxes under an NNN lease costs $18,500 in taxes.

How to Avoid These Mistakes

1. Robust Bookkeeping:
   • Use software like QuickBooks to track expenses. Keep receipts for seven years.
   • Action: Review your expenses every month and hire a bookkeeper for accuracy.
2. Leverage Depreciation:
   • Conduct cost segregation studies to speed up deductions.
   • Claim 100% bonus depreciation for assets placed in service after January 19, 2025, per OBBBA.
   • Action: Get a study for recent purchases and file Form 3115 for retroactive deductions.
3. Plan 1031 Exchanges:
   • Hire a Qualified Intermediary and set reminders for 45- and 180-day deadlines.
   • Action: Consult a 1031 specialist before selling and utilize a checklist to track deadlines.
4. Claim Tax Credits:
   • Find credits like Section 179D, Historic Rehabilitation, or OBBBA’s QPP deduction
   • Action: Check properties for eligibility and keep energy certifications.
5. Optimize Leases:
   • Use NNN leases to pass expenses to tenants.
   • Action: Prepare clear lease agreements with legal help and track tenant-paid expenses.
6. Engage Experts:
   • Hire CPAs or tax attorneys for compliance and strategic planning.
   • Action: Plan annual tax reviews to check deductions and law updates.

Strategic Takeaways

• Record-Keeping: Use software to log all deductions.
• Depreciation: Maximize deductions with cost segregation and bonus depreciation.
• 1031 Exchanges: Carefully track deadlines with a qualified intermediary.
• Tax Credits: Investigate credits during renovations or in Opportunity Zones.
• Leases: Align lease structures with tax goals.
• Stay Informed: Monitor OBBBA’s permanent provisions and other tax law changes.

Case Study

An owner of a $4 million warehouse (purchased in 2021 with $400,000 income) makes errors: misses $80,000 in expense deductions ($29,600 in taxes), depreciates $3 million over 39 years ($76,923 annually) instead of using cost segregation or 100% bonus depreciation (post-1/19/2025), and misses a 1031 exchange on a $1 million gain ($238,000 in taxes).

Corrective Actions:

• Uses QuickBooks to track $80,000 in deductions.
• Conducts a cost segregation study, claiming $300,000 in catch-up deductions ($111,000 savings).
• Claims 100% bonus depreciation for a $500,000 renovation in 2025 ($185,000 savings).
• Hires a QI to defer $238,000 in taxes.

Total Savings: $325,600 in one year ($29,600 + $111,000 + $185,000), plus $238,000 deferred.

Conclusion

Avoiding tax mistakes such as poor record-keeping, depreciation errors, missed 1031 deadlines, neglected credits, or improper leases saves thousands. OBBBA’s permanent 100% bonus depreciation and QPP deduction improve tax strategies for assets placed in service after January 19, 2025. Strong systems, professional expertise, and proactive planning ensure compliance and maximize returns.

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