Keeping Gains from Smart Commercial Property Investments Duty-Free
As 2017 draws to a close, it’s time for commercial real estate asset management companies and investors alike to reap the rewards of foresight and investments, particularly in growing areas like Saskatchewan. But come early 2018, benefits from these rewards might become muddled when the tax season comes around, especially if investors will be taxed significantly for the asset’s increased value.
To help investors navigate the burden of increased taxes, commercial real estate asset management companies have identified some ways for leveraging higher returns on investment into gains that can be truly enjoyed:
To Depreciate or Not: What You Need to Know about Electing CCA
The value of real estate generally increases or appreciates under favorable economic conditions and through value-adding initiatives, such as improved infrastructure or increased tenant activity. However, with higher returns through commercial real estate investments, it could also mean increased taxes. That’s why commercial real estate asset management companies look into depreciation for income tax purposes.
Known as Capital Cost Allowance (CCA), depreciation can be an effective method for sheltering real estate income from current taxes. This is achieved by transferring the obligation to future tax years. By amortizing a portion of the cost of a rental property invested in growing areas, such as Saskatchewan against the income generated from the investment, investors can leverage about 4% of the cost of investment on a declining basis year after year.
Electing CCA? Consider this First
Commercial property investment advisors note the CCA can be recaptured during the year that the property goes up for sale. The historical CCA taken will be added back to the income tax return if the property is sold for more than its current, un-depreciated capital cost (the value of the property less the CCA claimed on prior tax returns). This recapture can significantly impact the investor’s taxes during the year the property is sold.
That’s why commercial real estate management companies tend to hold on to properties for long periods and then elect CCA to reduce rental profits, lowering the taxes, while building on the investment.
Another strategy that can be employed is forfeiting CCA during years where the taxable income is lower. This allows the investor to claim a higher CCA in the following years as the marginal tax rate increases.
Flip or Flop: Navigating Capital Gains
When acquiring commercial investment properties in growing areas like Saskatchewan, asset management companies typically ‘flip’ these first. These properties are renovated and better maintained to generate more income. Later on, when the value of these properties have significantly grown and are sold, the resulting capital gains can be favorable. Typically, only half of the capital gains are subject to income tax; this allows investors to enjoy favorable returns from their initial investment.
A word of caution: the CRA makes a distinction in terms of short-term property flips. Acquiring properties, renovating , then selling these properties over a short period of time has become a profitable business model. Hence, the profit margin at which the property is sold can be considered by the CRA as income earned, rather than capital gains due to increased value of the renovated property. When the property is sold, those who invested in it can be taxed the full gain at their marginal tax rate, since the property was used to generate an income.
This is a large reason why asset management companies don’t just flip commercial properties on a short-term basis. Instead, the more logical approach is to diligently acquire assets, renovate, redevelop, expand or re-manage the structure of the asset, and sell when profitable capital gains can be realized.
The Necessity of Documents
Keeping tabs on key documents that support commercial real estate investments is especially crucial for tax purposes. Without proper documentation of transactions, in the eyes of the Canada Revenue Agency (CRA), these might as well not exist. This would be the best time for asset management companies and investors alike to reconcile records and accounting information, well ahead of the rush during tax season.
End 2017 on a high note with favorable investment returns on Saskatchewan’s most promising commercial properties. A real estate asset management company can help savvy investors face the upcoming tax season head-on.