Is Buying a Building for My Business Tax Deductible?

When a business owner considers acquiring a building for operations, the cost of purchasing it for business use is not immediately deductible. Instead, the Internal Revenue Service (IRS) allows businesses to recover this cost over a period of years through a process known as depreciation. Understanding these tax implications is important for effective financial planning and maximizing the tax benefits associated with business real estate ownership.

Understanding Depreciation

Depreciation is an accounting method that systematically allocates the cost of a tangible asset over its useful life. For tax purposes, the IRS acknowledges that assets like buildings experience wear and tear, obsolescence, or deterioration over time. This gradual reduction in value allows businesses to deduct a portion of the asset’s cost each year. By spreading the cost over time, depreciation helps to reduce a business’s taxable income annually and allows businesses to recover the capital invested in the property.

Determining the Building’s Tax Basis

The “tax basis” of a building is the amount from which depreciation deductions are calculated. This basis is generally the purchase price of the property, adjusted by certain acquisition costs. It is important to include various settlement and closing costs that directly relate to the acquisition of the property. These costs can include legal fees for title search and contract preparation, recording fees, transfer taxes, and charges for installing utility services. Owner’s title insurance and survey fees also typically become part of the building’s tax basis.

A crucial aspect of determining the depreciable basis is distinguishing between the building and the land it occupies. Land is generally not subject to depreciation because it is not considered to wear out or be consumed over time. Therefore, the total purchase price must be allocated between the non-depreciable land and the depreciable building. Common methods for this allocation include using the proportionate ratios from property tax assessments or obtaining a professional appraisal that specifies separate values for land and building. Any improvements made to the building before it is placed in service for business use, such as initial renovations, also add to its tax basis.

Claiming Depreciation and Other Deductions

Once the building’s tax basis is established, businesses can begin claiming depreciation. For most commercial properties, the Modified Accelerated Cost Recovery System (MACRS) is the required depreciation method. Under MACRS, non-residential real property typically has a recovery period of 39 years, meaning the cost is generally deducted in equal portions over this timeframe using the straight-line method. This annual depreciation deduction is reported to the IRS on Form 4562.

In addition to depreciation, businesses can deduct various other ongoing expenses associated with owning and operating a commercial building. Property taxes paid on the commercial property are generally fully deductible in the year they are incurred. If a mortgage is in place, the interest paid on that loan is also typically a deductible business expense. Other common deductible costs include business insurance premiums, utilities, and certain professional fees.

It is important to understand the distinction between repairs and improvements for tax purposes. Repairs are activities that maintain the property in its ordinary operating condition and do not significantly add to its value or extend its useful life. Examples include patching a roof leak or fixing a broken fixture, and these costs are generally deductible in the year they are paid. In contrast, improvements enhance the property’s value, extend its useful life, or adapt it to a new use. Costs for improvements, such as replacing a roof or installing a new heating, ventilation, and air conditioning (HVAC) system, must be capitalized and depreciated over time, similar to the original building cost.

Record Keeping for Tax Purposes

Maintaining accurate records is important for substantiating tax deductions related to owning a business building. Documentation helps ensure compliance and supports claims during audits.

These records should include the original purchase agreement and closing statements, which provide the initial cost and allocation of value. Any appraisals obtained during the acquisition process should also be kept. Invoices and receipts for initial improvements support the adjusted tax basis. Ongoing records for property tax bills, mortgage interest statements, utility bills, insurance premiums, and repair and improvement expenses must be retained. These records are also important when the property is sold, as they are needed to calculate the gain or loss for tax purposes.