5 Tax Advantages of Investing in Commercial Real Estate Funds
Introduction
Investing in commercial real estate (CRE) funds can deliver attractive returns, but one of the biggest unseen benefits is tax efficiency. If you’re considering private commercial real estate investment funds, understanding how taxes work can help you keep more of your returns. Below are five key tax advantages that accredited investors, family offices, and institutions should know.
1. Depreciation Deductions Lower Taxable Income
CRE properties are depreciable under IRS rules (typically over 39 years for commercial buildings). This means you can deduct a portion of the building’s cost each year—even while it may appreciate in value. This depreciation can offset rental income, reducing your taxable income.
2. Cost Segregation Accelerates Depreciation
A cost segregation study breaks down a property into components (e.g., flooring, HVAC, fixtures) that may have shorter depreciation schedules (5, 7, or 15 years) instead of the standard 39 years. That front‑loads deductions, boosting early‑year cash flow and tax savings.
3. 1031 Exchanges Defer Capital Gains Taxes
When you sell a CRE property or fund interest, a 1031 like‑kind exchange allows you to roll over proceeds into a similar investment without paying capital gains immediately. This defers taxes, letting more capital stay invested and grow.
4. Interest Expense & Operating Costs Are Deductible
CRE funds often use debt financing. Interest on loans, property management, maintenance, insurance, and other operating expenses can be deducted, helping reduce the taxable income from the property. (Mack Capital)
5. Qualified Business Income (QBI) Deduction & Pass‑Through Tax Treatment
Many private real estate funds are structured as pass‑through entities (like LLCs or partnerships). This enables eligible investors to benefit from deductions like the QBI deduction (up to 20%) under U.S. tax law, reducing tax liability on qualifying income. Also, pass‑through status avoids double taxation. (Mack Capital)
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FAQs
Question | Answer |
Can depreciation recapture hurt me when I sell? | Yes — when you sell, the IRS may tax the depreciation taken as “recapture.” But even with recapture, you often still benefit because deductions over the years reduce taxable income during holding. |
Does every CRE fund allow cost segregation? | Not always. It depends on the property type, renovations, and whether the fund sponsors conduct the cost segregation study. Always check the fund’s documents. |
How long must I hold for a 1031 exchange? | You must meet strict IRS timelines: identify a replacement property within 45 days and close within 180 days. Also, reinvest in like‑kind properties. |
Is the QBI deduction available for all investors? | No. There are income thresholds, active participation requirements, and fund structure factors that determine eligibility. Consult your tax advisor. |
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