Optimized tax strategies are crucial in today's competitive commercial real estate market. The good news is that the U.S. tax code offers a variety of incentives and deductions designed to help multifamily property owners reduce tax liabilities, increase return on investments and improve cash flow. But keeping up with evolving regulations and requirements isn't always easy. This article provides an overview of six key tax strategies to be aware of and discuss with your tax advisors.

Cost Segregation Studies

How they work: A cost segregation study is a strategic tax planning tool that allows multifamily property owners to accelerate depreciation deductions and reduce tax liabilities in the early years of ownership. This study involves a detailed analysis by engineers to categorize various building components, such as roofing, plumbing and wiring, each with its own depreciation timeline.

Key benefits: By accelerating depreciation, property owners can substantially reduce their federal tax liability, improving cash flow and potentially freeing up capital for reinvestment into their properties or other investments. Look-back cost segregation studies can be performed retroactively on properties acquired, remodeled or expanded in prior years, allowing owners to take unrecognized depreciation deductions in the current tax year.

What to watch out for: Cost segregation is a powerful tool for multifamily property owners to optimize their tax strategy and maximize the return on their investment. The studies require the expertise of licensed engineers and tax professionals due to the detailed physical inspection and classification of building components. As a result, cost segregation studies are typically recommended when property owners make acquisitions or building upgrades that exceed $500,000.

45L Tax Credit

How it works: The 45L tax credit is a federal tax incentive designed to promote energy efficiency in residential construction, including multifamily properties.To claim the credit, properties must be certified by an accredited expert using IRS-approved software.

Key benefits: The 45L credit, which ranges from $500 to $5,000 per unit based on the level of energy efficiency achieved and whether prevailing wage requirements are met, can significantly offset the costs associated with building or renovating energy-efficient multifamily properties. The credit has been extended through 2032 and can be applied retroactively to eligible projects by filing an amended tax return.

What to watch out for: The certification process requires careful planning and documentation. Multifamily property owners should work closely with energy-efficiency consultants and tax professionals to ensure compliance and maximize the benefits.

179D Tax Deduction

How it works: The 179D tax deduction is designed to encourage energy-efficient improvements in commercial buildings, including multifamily properties, that are at least four stories tall. To qualify for this federal deduction, the new construction or major renovation must achieve a certain level of energy savings compared to a baseline standard, encompassing improvements to the building envelope, HVAC systems and interior lighting. To claim the deduction, a third-party expert must certify that the building meets the required energy-efficiency standards. The IRS now requires the filing of Form 7205 to claim this deduction and will need to be completed by the provider who prepared the 179D study.

Key benefits: As of 2023, the maximum deduction increased significantly to $5.00 per square foot, up from the previous limit of $1.88 per square foot, following changes introduced by the Inflation Reduction Act (IRA) of 2022. In addition, the IRA reduced the minimum required energy savings from 50% to 25% and established a new bonus rate available on top of the base deduction. To qualify for the bonus deduction, property owners must meet local wage and apprenticeship requirements for laborers and mechanics employed for the project.

What to watch out for: All improvements must meet specific energy-efficiency standards defined by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) as of four years before the completion of construction. Maintaining comprehensive records of the energy-efficient improvements, certification process and associated costs is essential. Meeting prevailing wage and apprenticeship requirements, required for the highest deduction amounts, can increase labor costs and add complexity to the compliance process.

Tangible Property Regulations

How they work: Tangible Property Regulations (TPRs) determine the tax treatment of repair and improvement costs related to tangible property. Repairs, which maintain the property in its current condition, are generally deductible in the year they occur, providing immediate tax benefits. Improvements that add value, prolong useful life or adapt the property to a new use must be capitalized and depreciated over time, spreading the tax benefit across several years.

Key benefits: TPRs give multifamily property owners the ability to immediately deduct repair costs, which can significantly reduce taxable income in a given year and improve cash flow. Deductions can also be applied retroactively by filing Form 3115 in the current tax year as an automatic accounting method change.

TPRs include safe harbor provisions, which offer additional flexibility in expense treatment. The regulations’ partial disposition election allows property owners to recognize losses when disposing of portions of a property, providing strategic tax management opportunities.

What to watch out for: Proper classification of expenses as repairs or improvements is essential, as misclassification can lead to penalties and increased tax liabilities. TPR compliance requires detailed record-keeping and documentation to support expense categorizations and safe harbor elections. Consultation with experienced tax professionals ensures property owners are able to maximize TPR thresholds and partial disposition elections.

Pass-Through Entity Tax Provision

How it works: The Pass-Through Entity (PTE) tax provision can be a valuable tax strategy for multifamily property owners when state tax liabilities exceed the $10,000 State and Local Tax (SALT) deduction cap. The provision allows pass-through entities, such as partnerships, S-corporations and LLCs, to pay state income taxes at the entity level rather than passing them through to individual owners.

Key benefits: By shifting the tax burden to the entity level, the owners can benefit from full deductibility of state taxes on federal returns. This reduces the overall taxable income passed through to them and effectively bypasses the SALT cap for individual owners.

What to watch out for: It's crucial for property owners to carefully consider the specific rules and benefits in their state. Some states offer full or partial tax credits for PTE taxes paid while others provide income exclusions or alternative benefits. Multifamily property owners with holdings in multiple states should work with their tax advisors to assess the potential impacts and navigate the complexities of different state regulations.

Solar Investment Tax Credit

How it works: The Solar Investment Tax Credit (ITC) offers multifamily property owners a significant tax credit for solar energy systems placed in service after Dec. 31, 2021, through the end of 2032. The credit currently stands at 30% of the installation cost. The ITC is set to decrease to 26% in 2033 and 22% in 2034.

Beyond the base credit, multifamily property owners may also be eligible to claim additional bonuses, such as an extra 10% credit for using domestically produced materials and another 10% for installations in certain economically distressed areas or brownfield sites. In addition, based on provisions in the IRA, Low-Income Housing Tax Credit (LIHTC) properties may be able to claim solar tax credits without a reduction in the eligible basis.

Key benefits: The ITC offers substantial tax savings, significantly reducing the overall cost of solar installation. Property owners have the option to directly purchase and own the solar systems to claim these credits. Alternatively, in some states, they can opt for third-party ownership models where another entity owns the system, which can simplify the process for property owners who prefer not to manage the solar infrastructure directly.

What to watch out for: State-specific regulations, including rules for third-party ownership and additional state-level incentives, can vary widely. Engage a tax advisor to ensure you’re optimizing current opportunities and complying with all applicable regulations.

The dedicated commercial real estate experts at CBIZ can help you identify and optimize tax savings opportunities for your properties. Connect with a member of our team and gain access to more resources here.

This article includes input from Neil Sonenberg, Managing Director and co-leader of the Real Estate practice at CBIZ Marks Paneth, and Larry Rosenblum, Tax Managing Director with CBIZ CPAs P.C. With a specialtyin serving commercial real estate clients, Neil and Larry provide tax planning and commercial property cost segregation expertise to their clients.

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