What Investors Need to Know About Commercial Property Taxes

Commercial property taxes are more complex than residential taxes. Learn more to get all the deductions possible and make smarter financial decisions.

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What Investors Need to Know About Commercial Property Taxes

Posted by Gary Ashton on Sunday, February 6th, 2022 at 11:06am.

Everything to Know About Filing Property Taxes For Commercial Real EstateThose who own commercial real estate in Nashville or any other city are likely already aware that there will be taxes to pay at the culmination of the year. Commercial property tax determinations involve factoring in four general categories: property, federal, state, and local, and rental or sales tax. This process drastically differs from that of residential property tax assessments. Keep reading to become an expert on commercial real estate property taxes.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.

The Difference Between Residential and Commercial Property Taxes

Residential property taxes are calculated by a local assessor's determination of the property's value itself based on factors such as condition, high-ROI upgrades, and depreciation or appreciation in worth. They will then consider the value of similar properties and those nearby. This is how the overall taxable value of a residential property is determined.

Calculating commercial property taxes involves a much more complex process than residential structures. Commercial owners or financial professionals must complete an annual income and expense form and consider multiple tax areas. The form is very detailed, and its contents will ultimately determine a commercial property's actual taxable value.

Commercial Property Valuations and Taxes

Property tax liens on commercial real estate are similar to residential property taxes. Commercial properties are typically worth more than the average home, and they usually generate income. Hence, the tax bills are higher. There are three ways the market value of commercial properties is determined:

  • Sales Evaluation
  • Cost Method
  • Income Method

Many lenders will require the borrower to make monthly tax payments for the commercial property. Lenders may require these funds to be put into an escrow account, but other lenders might only require proof that the tax bills have been paid and are up to date.

Federal Income Taxes on Commercial Property

Commercial property owners must pay federal taxes on any net income generated by the business occupying the property. Keep in mind profits are not the same as gross income. This is why keeping detailed records of all operating expenses can be used as deductions for tax valuations.

Many savvy owners increase annual business expenses as high as legally allowed to reduce net income subject to federal taxes. Commercial investors should keep in mind that deposits from tenants aren't income. Instead, deposits are held as liabilities on the balance sheet. Should a deposit not be returned to a tenant, the funds can be utilized for repairs or improvements to reduce taxable net income.

Commercial Property State & Local Taxes

Most states and cities, including Nashville, tax commercial properties on their net income. Ultimately, state and local taxes for commercial properties are calculated similarly to federal taxes. That being said, when investors are determining rental rates for tenants, it's essential to factor in the amount of property, federal, local, and state taxes being paid. This allows owners to reduce out-of-pocket expenses by including these taxes in rental amounts.

Rental or Sales Tax on Commercial Property

States and cities often collect a set percentage of monthly rents investors receive from tenants. Rental or sales tax percentages are based upon gross income rather than net income. Again, leases should include a provision that lets the owner include these taxes into the tenant's monthly rent. Should tenant's businesses collect sales tax from clients, the tenant will be responsible for paying taxes directly to the city and state.

How Commercial Property Taxes are Calculated

After determining the calculated value of a commercial property, a percentage of the value is utilized to calculate property tax. Entities like the state, county, or town will often have set tax rates concerning vital services that support and improve municipalities, such as:

  • Schools
  • Water Districts
  • Roads
  • Infrastructure
  • Electrical Grids

All of these budgets are considered by assessors when they make a final determination on the percentage of taxes that will ultimately be levied on a commercial property.

The Tax Advantages of Commercial Property

Buying commercial property has five distinct tax benefits. These advantages are available for investors in properties both large and small. Here are some tax savings that commercial real estate owners shouldn't miss out on.

Interest Expenses

Interest paid on the mortgage for a commercial purchase qualifies as a deduction. Any payments made during the year for mortgage payments can be deducted from the business's tax bill.

Depreciation Expenses

Almost from the moment of purchase, property has the potential to depreciate or appreciate. However, owners of older buildings will quite frequently find themselves able to offset their tax liability due to depreciation expenses.

Post-sales Tax Savings

Should a property fall into the hands of beneficiaries and they opt to sell, they will only be required to pay tax on any increases in the property's value since the time they took control of it.

Non-Mortgage Related Expenses

Any renovations, maintenance, ongoing upgrades to improve curb appeal, and other expenses of owning a commercial property may qualify as potential deductions. These are out-of-pocket expenses, but they ultimately can help improve the property's value. The tax deduction can often help owners recoup a good portion of those expenditures.

Capital Gains

A lower capital gains tax rate is a possible benefit that a commercial property can offer versus other retirement investments like IRAs. While selling a commercial property has tax implications, the capital gains tax rate connected to the sale typically is lower than standard personal tax rates associated with an IRA. An exception is Roth IRAs because taxes are paid when invested.

Handle Commercial Property Taxes Like a Pro

It's undeniable that the realm of commercial property taxes is far more in-depth than routine residential taxes. Get all the deductions possible and make smarter financial decisions concerning the property with guidance from an experienced commercial property tax professional or a real estate agent with a background in commercial investments.

For informational purposes only. Always consult with an attorney, tax, or financial advisor before proceeding with any real estate transaction.


Gary Ashton

The Ashton Real Estate Group of RE/MAX Advantage

The #1 RE/MAX team in the World!

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