NNN Tax-Saving Techniques

Oct 11, 2019

NNN Returns Can Outweigh Other Investments

Triple-net (NNN) property investments are tangible assets with steady cap rates that preserve cash flow and yield reliable monthly income. Multiple tax-saving techniques, including cost segregation depreciation (CSD) and the 1031 exchange, alongside other factors, can boost the return on your investment (ROI) and put triple-nets in line with other fixed-income investments and funds. In some instances, NNN returns can outweigh these other investments. Take a look at the tax laws and wealth-building tips below to get the most out of your NNN investment.

Trading graph on the cityscape at night background. Business and financial concept. Double exposure. Singapore

Cost Segregation Depreciation (CSD)

Depending on your property and individual tax variables, cost segregation depreciation may allow non-structural improvements, such as carpet, indoor and outdoor lighting, heating and cooling systems, and landscaping to be depreciated over five, seven, or 15 years, versus 27.5 or 39 years.

This substantially shorter depreciable tax life helps you preserve capital, realize immediate cash flow, and achieve significant tax relief on new and existing buildings. These benefits are also gained through asset reclassification and write-offs when the asset is sold. In summary, CSD allows you to:

  • Adjust the timing of deductions to maximize tax savings.
  • Swiftly depreciate expenses.
  • Reduce/defer current tax liability.
  • Increase cash flow for other investment opportunities or operating expenses.
  • Take 100% of the adjustment (on buildings purchased after September 2017) in one year.
  • Re-claim deductions dating back to 1987 without having to amend tax returns.
  • Create an audit/paperwork trail that satisfies the IRS’s audit techniques guide (ATG).

Concept of investment income and growth with money tree in pot

How to Utilize CSD

The only way to determine if your NNN property qualifies for the maximum CSD benefit is to have engineering, architecture, construction, or tax accounting specialists perform a cost segregation study (CSS). To satisfy the IRS’s strict guidelines, it’s imperative that your CSS be performed by a highly accredited firm that determines the cost estimates and allocations in accordance with the law. This also ensures you don’t leave any money on the table.

income real estate investment

Benefits on New & Existing Properties

A CSS is performed when buying a new building, but many investors don’t realize it can also be performed on a building owned for many years – new deductions can be taken back to 1987 without amending tax returns. A study is also advantageous when you finish new construction or complete redevelopment or renovation of an existing building.

It is important to note that if you currently own commercial property, consult your CPA about your individual tax situation and whether CSD would work for you. If you’re considering a new NNN lease property, Westwood Net Lease Advisors can make a CSS part of your initial analysis to determine if the property is a worthwhile purchase. We work with reputable CSS preparers with referenced credentials and expertise – we would be happy to connect you and help you with the process.

Can I write off interest expense on debt? Yes, but how you do it and how much depends on your tax situation. It’s best to talk to your CPA about your interest expense write-off options.

1031 Exchange − Deferred Capital Gains Taxes

When you sell a commercial property for another or trade-up to a hassle-free NNN property, you may avoid capital gains taxes with a §1031 exchange. With this tax code, the money you would have thrown away paying taxes is preserved. You can make a larger down payment on your new property or perhaps use the money to buy two properties. As long as you reinvest and meet the timeline and IRS’ criteria, you could defer taxes indefinitely − it’s basically an interest-free loan from the government! This tax code allows you to:

  • Sell any commercial property and/or trade-up from a high-maintenance to a low-maintenance property (i.e.: apartment complex to a triple-net lease investment).
  • Diversify your holdings by exchanging one property for two or three.
  • Relocate your investment to a growing part of town or area of the country.
  • Bolster your real estate investment portfolio with deferred taxes (possibly indefinitely).

commercial real estate expenses

After-Tax NNN Income Can be Higher Than Stock Market Returns

NNN investments mimic fixed-income investments by providing asset and income growth, strong current yields, long-term predictability, and steady cash flow for up to 20 years or more. When you own stocks and bonds, the value fluctuates daily with market whims and lies strictly within a piece of paper promising repayment or income.

A NNN property provides steady immediate income with predetermined increases and annual tax benefits. It is not subject to stock market volatility and offers a lease guarantee that bolsters the asset. This legally binding long-term lease with a national corporation and strong tenant assures your monthly rental income stays stable. There’s also the tangible underlying real estate value, which adds leverage and physical security to the investment. The bottom line is this: when adjusted for inflation, ten-year stock market returns of 10-12% lose 2-3% annually, providing a realistic 7% to 9% return, which is in line with income-producing, capital-preserving NNN investments.

Buy in States with No Income Tax

Since absolute NNN lease properties require little to no involvement from the landlord, it may fit with your goals and logistics to buy in one of the states that do not have state income tax. Those states are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. New Hampshire and Tennessee also have more reasonable dividend taxes. This can be a savings of up to 9.9%, depending on the state.

How is after-tax revenue higher in real estate than other investments? The ability to write off depreciation and interest, as well as other property expenses, plus the power of positive leverage, is unique to real estate and particularly beneficial with NNN properties.

CRE loan lenders

Cash-On-Cash Return

Let’s start by explaining how the capitalization rate or cap rate and cash-on-cash (CoC) return differ and what that means for your tax savings techniques. The cap rate is the level of risk and equity return on your NNN investment and is never calculated using financing. It compares the purchase price of a property to the income it generates. To calculate, divide net operating income (NOI) by the purchase price to give you a natural rate of return for a single year. The NOI is simply the annual rental income minus the operating expenses.

The CoC provides an analysis of your return based on the actual money you put in and is dependent on financing. It is the pre-tax cash flow divided by the total amount of cash invested (not the total purchase price), which includes money used to purchase the property, closing costs, capital expenditures, and loan fees. To calculate, divide the cash flow before tax by the amount of cash initially invested.

It’s imperative to know the realistic cap rate and CoC before you buy − these are often inflated to make a sale look more appealing. A buyer’s advisor can do a more in-depth analysis of both to give you a more accurate estimated return and explain the tax implications and benefits of your investment based on these two numbers.

Is it true that a 6% cap rate can equal a 9% return due to tax benefits like depreciation? Oftentimes, the cap rate can be much higher than stated due to deprecation and/or cost segregation and the other write-offs mentioned.

like-kind properties handled by a real estate agent

To Wrap it Up – NNN Tax Savings Preserve Capital

When NNN property owners consider the many tax advantages and incremental rent increases over the 10- to 20-year lease term, in some circumstances, a 6% cap rate can ultimately amount to an 8-10% return. There are also the additional benefits of a totally passive, consistent monthly income with no expenses, a tangible asset that offers more buying power, and a higher cash-on-cash return. There is a surety of income with NNN properties not often found in other types of investments.

To acquire the right property with the best tax advantages, it’s best to use a buyer’s advisor who gets to know you and your goals and has extensive knowledge of NNN tax implications and how they will best work for you.  Westwood Net Lease Advisors specializes in 1031 exchanges and is industry-unique as one of the only companies in the nation that primarily represents buyers, from the property search to closing, at no cost to the buyer. Contact us today to learn more about NNN tax benefits in a free consultation, 314-997-5227.

Looking To Buy Commercial Property?

Find out why triple-net lease real estate investments should be part of your investment portfolio.