The implementation of tax reform is on the horizon, and economists say it will be favorable for commercial real estate companies.
The prediction has left many feeling uncharacteristically cheery about tax season. But New York City’s tax codes are notoriously complex, and not knowing the rules, or consulting a tax professional who does, can have dire consequences.
Avoiding these six common tax mistakes can help NYC owners and developers plan ahead and prevent overpayment or painful audits.
1. Classify Correctly
Accounting is nuanced, and it is easy to make mistakes. One such error results from not knowing what constitutes a capital expenditure versus repair and maintenance activity. This can cause CRE pros to significantly overestimate or underestimate their tax liability.
According to Mazars partner Ron Lagnado, significant renovations, remodels or knockdowns can trigger the New York State Department of Taxation and Finance to conduct an assessment of the property’s bookkeeping, as these improvements are frequently recorded incorrectly.
Although categorizing capital expenditures is complex, they must become part of the property, add value to it and represent a permanent installation.
2. The Harsh Reality Of Real Property Transfer Tax
New York State imposes a real property transfer tax on transactions over $500 and when the controlling interest of a corporation, partnership or trust that owns or manages real estate assets is sold.
“Neglecting to consider real property transfer tax to the extent applicable when contemplating an asset sale can have consequences,” Mazars partner Kyle Wissel said. “In New York City, that tax can be about 3%, so it’s a meaningful amount.”
3. Condo Cash Conundrum
A potential supply glut of luxury high-rises is not the only danger NYC condo developers have to contend with. Even after successfully selling their units, unforeseen taxes may threaten their bottom lines.
“When a developer sells condos, they need to make sure that there is a carve-out for taxes in the underlying mortgage documents,” Mazars partner Donald Bender said. “If not, typically all the proceeds from the sale of condo units go to pay down mortgage debt, and the developer has no money left to pay taxes on the sale of the condo units.”
4. Closing Cost Considerations
Closing costs are expenses above the purchase price agreed to in the contract, and may be paid by the seller or buyer of the asset.
“Periodically, our clients fail to properly estimate the amount of the closing costs or closing adjustments,” Mazars partner Ed Ichart said.
Buyers and sellers may be surprised to discover funds will be held in escrow for future payments of real estate taxes, title insurance, loan origination fees or appraisal fees.
“They don’t realize all of the costs that are required upon the purchase of a property and the related debt incurred,” Ichart said.
5. Watch Your Language
Commercial property buyers must proceed with caution with documents that can affect Purchase Price Allocation. PPA is the process of assigning fair market value to all assets after an acquisition, including their identifiable value, value of intangibles and goodwill.
“When purchasing real estate assets, one must draft sale documents and any accompanying schedules in such a way to provide flexibility in determining allocations of purchase costs,” Mazars Director Joe Strickland said. “Significant tax benefits can result by not locking yourself into a predetermination of purchase cost allocations that may benefit the seller, but may severely limit your tax-saving opportunities available through a cost segregation study.”
6. Ensure Contracts Are As Structurally Sound As Buildings
The NYC CRE market is one of the most highly regulated and taxed, which elevates the importance of a comprehensive tax strategy.
“A common mistake developers make when purchasing a property is poor tax structuring,” Mazars partner John Ohannessian said.
According to Ohannessian, the standard life cycle of real estate includes the acquisition, the operating period and property disposition. Developers must consider the tax implications of each stage in the cycle at a deal’s inception.
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