The Impact of State and Local Taxes on Commercial Real Estate: What Business Owners Should Know
For businesses involved in commercial real estate, understanding the impact of state and local taxes is crucial to making informed investment and operational decisions. Whether you’re buying, selling, or managing properties, taxes play a key role in shaping profitability and long-term strategy. As of October 2024, navigating the tax landscape is particularly challenging due to evolving regulations and varying state tax policies. To minimize tax burdens and maximize profitability, we must breakdown the core components of state and local taxes.
1. Property Taxes: The Biggest Local Tax Factor
Property taxes are often the most significant ongoing expense for commercial real estate owners. These taxes are levied by local governments, including counties and cities, and the rates can vary widely based on location. Property taxes are calculated based on the assessed value of the property, which may change periodically, affecting the overall tax burden.
In high-tax states like California and New York, commercial property taxes can be a major expense. For example, California’s Proposition 13 limits how much property taxes can increase year-over-year but also causes new properties to be assessed at much higher values than older ones. As a result, property owners must plan for these assessments and consider how they impact cash flow. Consulting with experts, like those at Whittaker & Company, can help identify potential tax-saving strategies, such as challenging an over-assessment of your property’s value.
2. State Income Taxes and Their Influence on Real Estate
State income taxes also play a significant role, particularly if you operate a real estate investment company or hold property through a corporation. In states like Florida and Texas, which have no state income tax, investors may see more favorable returns. However, other states—such as New York and Illinois—impose relatively high corporate income taxes that can diminish profitability.
Tax planning in this area is crucial. Working with a CPA who specializes in proactive tax planning can help you structure your business to minimize exposure to higher state income taxes. For instance, forming an LLC or S-corporation in a state with favorable tax rates could reduce your tax burden significantly.
3. Sales and Use Taxes
Sales and use taxes come into play for businesses that purchase materials or equipment related to property improvement or operations. These taxes vary from state to state and can apply to everything from construction materials to office equipment. For example, in states like Washington and Arizona, sales tax can be as high as 10% when local taxes are added. This means increasing the cost of maintaining or upgrading commercial properties.
Understanding when and where sales taxes apply is crucial when you’re involved in large-scale commercial construction or property improvements. Many states offer exemptions or credits for certain types of equipment or energy-efficient upgrades. Because of this, knowing which tax benefits are available could save you substantial amounts in the long run.
4. Transfer Taxes and Capital Gains
Another major tax to consider is the transfer tax, which applies when property is sold or transferred. These taxes are typically imposed by local governments, and their rates can range from less than 1% to over 4% of the property’s sale price. For example, New York City has both state and city transfer taxes.
In addition to transfer taxes, capital gains taxes also impact real estate investors when properties are sold. The IRS requires federal capital gains taxes to be paid on the profits from the sale, and many states also impose their own capital gains taxes. Strategies such as 1031 exchanges, which allow you to defer paying capital gains by reinvesting in a similar property, can be essential for reducing tax burdens. This is where proactive tax planning by firms like Whittaker & Company can be particularly helpful.
5. How to Reduce the Impact of Taxes
To effectively manage the tax implications on commercial real estate, consider the following strategies:
- Tax-advantaged Structures: Using tax-efficient business structures like LLCs or S-Corporations can help limit state and local tax exposure.
- ProActive Tax Planning: Engage in year-round tax planning rather than waiting until tax season. This can help identify opportunities to minimize tax liabilities, particularly through tax credits, deductions, and incentives that might be overlooked.
- Understand Local and State Incentives: Many states and municipalities offer tax incentives to encourage investment in certain areas. For example, states like Ohio and Indiana provide tax abatements for businesses investing in specific development zones.
- Monitor Changes in Tax Legislation: Keeping up to date with tax law changes can help you stay ahead of potentially costly adjustments in tax policy. Changes to property tax assessments in high-growth areas could increase your tax bill unexpectedly.
State and local taxes can significantly affect the profitability of commercial real estate investments. Understanding how property taxes, income taxes, sales taxes, and transfer taxes apply to your business—and using proactive strategies to minimize their impact—can save you substantial amounts. By working with an experienced CPA firm like Whittaker, you can navigate this complex landscape. We can help ensure that you’re paying the least amount of tax legally possible.
If you think your business could benefit from ProActive Tax Planning or you have questions about state and local taxes on your real estate holdings, contact us today to learn more about our tailored services.
