Arizona Commercial Property Depreciation and Other Tax Benefits You Should Know About
In the State of Arizona, commercial property owners need to account for commercial property taxes as part of the ongoing expense of ownership. However, as a major incentive for Arizona property owners, the state provides an enhanced commercial property depreciation method to help owners pay less tax on the properties themselves and any rental income associated with those properties.
Let’s take a closer look at this Arizona tax benefit and discuss a few other tax deductions Arizona commercial property owners should know about.
Commercial Property Taxes: A Quick Run-Through
Property taxes are common almost everywhere, but commercial properties tend to be taxed at higher rates because they have a higher assessment value and because of their ability to generate revenue.
The Arizona Department of Revenue establishes commercial property taxes, but the taxes themselves are assessed and collected by the county in which the property resides. The revenue from these taxes is generally put back into the community, paying for services such as schools, roads, parks, emergency services, law enforcement, etc.
Commercial property tax rates are determined locally by each county, so the actual percentage at which your property is taxed depends on its location. For some counties, the process is simple, while in others, it is more complex. Santa Cruz County, for example, uses a complex formula that practically assesses a specific tax rate per individual property. On the other hand, Maricopa County’s commercial tax rate is simply 18 percent of the limited property value (LPA).
Another point to note is that Arizona also assesses commercial property tax on rental income generated by the property, not just its value. Property owners need to take this into account when figuring out their annual tax burden.
How Can Commercial Property Owners Pay Less Tax?
One of the most effective ways to mitigate commercial property taxes in Arizona is through a provision called commercial property depreciation.
Commercial Property Depreciation
In 2011, to encourage more commercial investment in the state, Arizona introduced an enhanced additional depreciation formula that allows substantial property depreciation in the first five years of use.
Under this tax rule, an eligible commercial/industrial property classified in the tax year 2012 or thereafter may reduce the property’s full cash value for tax purposes by 75 percent in the first year of use, 59 percent in the second year, 43 percent in the third, 27 percent in the fourth, and 11 percent in the fifth.
By reducing the property’s assessed value each year in this way, property owners can save a substantial amount on taxes.
Tax Deductible Expenses for Commercial Properties
In addition to the tax-saving method of commercial property depreciation, commercial property owners can add to their tax savings even further by knowing how to deduct certain expenses – especially by capitalizing eligible expenses like property improvements. Let’s explore this idea a bit further.
Which commercial property expenses are tax-deductible?
Both the Arizona Department of Revenue and the IRS allow certain tax deductions for commercial properties. These include, but may not be limited to:
- Mortgage interest. Just as with residential properties, commercial property owners can deduct mortgage interest from their annual taxes.
- Management expenses. Certain costs associated with managing your property (e.g., travel, payroll) may be tax-deductible.
- Repairs. Upkeep and maintenance costs may be tax-deductible.
- Upgrades and improvements. Important building enhancements and necessary renovations (such as roof replacements or recoating) may be tax-deductible, as well.
What is capitalization?
Capitalization is another useful accounting method that may help reduce your tax burden across a span of time. With capitalization, the cost of an item is effectively spread across the item’s expected life span (rather than expensed for the full amount immediately). For example, if you purchased a piece of equipment for your property valued at $200,000 and the piece of equipment is expected to operate for 10 years, you could calculate the annual cost of that equipment at $20,000 per year – or more incrementally using a formula for depreciation.
Capitalization is a useful method for spreading the tax benefits of an expense over several years.
How can you capitalize the cost of commercial property improvements?
Certain improvements to commercial properties (like roof replacements) can also be capitalized to extend the tax savings of that improvement over the life expectancy of the improvement itself. (For a new roof, for example, you may be able to capitalize it over a period of 20 years or more, depending on the roof’s life expectancy.). Generally speaking, a building improvement can be capitalized (rather than expensed) if it meets any of the following criteria:
- It is a betterment of the property. For example, it adds space, fixes a defect, increases productivity, etc.
- It is a restoration of the property. It replaces something essential that has worn out, for example.
- It is an adaptation of the property. The improvement serves to alter the building’s function or purpose.
Tax benefits like commercial property depreciation can be advantageous for investors and commercial property owners in Arizona who seek to minimize their property tax burden. Likewise, knowing how to take advantage of other tax benefits, such as capitalizing improvements, can significantly lower your tax bills. That being said, it’s always best to confer with your tax professional to learn more about specific tax advantages for which your property might be eligible.
Before investing in a roof repair or replacement, commercial property owners should always do some research to find out which processes offer tax benefits – and which improvements may be more beneficial than others.
Contact RoofSource for your commercial roofing assessments. We assess new roofing installations, conduct routine inspections, inspect commercial roofs for damage and leaks after major events, and perform due diligence inspections before or after a commercial property sale.