Commercial property tax is a significant consideration for property owners, investors, and businesses involved in commercial real estate.
Understanding how these commercial property taxes are calculated, the factors influencing them, and strategies to manage tax liabilities can lead to more informed investment decisions and boost your net operating income (NOI).
Our article will walk you through everything you need to know about commercial property taxes.
Understanding Commercial Property Taxes
Local governments levy commercial property taxes on properties used for business purposes, such as office buildings, retail spaces, industrial facilities, and multi-family or rental properties.
But what’s their purpose?
These taxes are municipalities' primary revenue source, funding essential public services like education, infrastructure, and emergency services.
Thus, whether you’re a commercial real estate or single-family investor, monitoring your property taxes is essential for financial planning.
Moreover, property tax assessment methods and rates vary significantly by jurisdiction. So, it’s crucial to stay informed about your area’s unique property tax laws and due dates.
Local governments levy commercial property taxes on properties used for business purposes, such as office buildings, retail spaces, industrial facilities, and multi-family or rental properties.
But what’s their purpose?
These taxes are municipalities' primary revenue source, funding essential public services like education, infrastructure, and emergency services.
Thus, whether you’re a commercial real estate or single-family investor, monitoring your property taxes is essential for financial planning.
Moreover, property tax assessment methods and rates vary significantly by jurisdiction. So, it’s crucial to stay informed about your area’s unique property tax laws and due dates.
How Commercial Property Taxes Are Calculated
The calculation of commercial property taxes typically involves two main components: the property’s assessed value and the applicable tax rate.
The property’s assessed value depends on how the county or municipality values the commercial properties.
Property Valuation
The valuation process of commercial properties often involves various approaches. The most common are these:
1. Income Approach:
This method estimates the property's value based on its potential to generate income. County assessors analyze the property's net operating income, considering rental income, occupancy rates, and operating expenses.
So, to find the assessed value, the assessor takes the net operating income (rental income minus expenses) and divides it by the capitalization rate (which shows how risky the investment is).
Net Operating Income (NOI) Defined:
Net operating income is a key financial metric used in commercial real estate. It represents a property's income after deducting operating expenses, like maintenance, utilities, property management fees, and property taxes, but before accounting for debt service (mortgage payments) and income taxes.
You calculate NOI by subtracting these operating expenses from the total rental income.
Capitalization Rate (Cap Rate) Defined:
The capitalization rate is a rate of return used to estimate the value of an income-generating property. It’s calculated by dividing the property's NOI by its market value. The cap rate reflects the market's expectations for the property's risk and return potential.
A higher cap rate indicates a higher perceived risk and lower property value.
A lower cap rate indicates a lower perceived risk and a higher property value.
For example, if a property has an NOI of $150,000 and a market cap rate of 6%, its estimated value would be $2,500,000 ($150,000/0.06).
2. Cost Approach:
The cost approach considers the current cost of constructing a similar structure minus any depreciation due to age or condition.
This approach is often used for newer properties or with unique features that make it challenging to find comparable sales data. However, the cost approach relies on several estimates and assumptions and may not always accurately reflect a property's market value.
3. Sales Comparison Approach:
This method involves comparing the subject property to similar recently sold properties in the same market. Differences in size, location, and features are adjusted to estimate the property's value.
Assessors often use it to determine the market value of residential properties.
Applying Assessed Value, Exemptions, and Tax Rates
To compute the total property tax for a commercial property, you need the assessed value, exemptions, tax rates, and total tax liability.
Assessed Value: Determine the property's estimated market value as appraised by your local county appraiser.
Exemptions: Subtract any applicable exemptions to arrive at the taxable value
Tax Rates: A sum of the tax rates for all relevant taxing jurisdictions, e.g., county, city, school, and community college taxes.
Total Tax Liability: Multiply the taxable value (assessed value - exemptions) by the combined tax rates.
For example, if a commercial property in Austin has a taxable value of $1,000,000 (post exemptions) and the combined tax rate from all taxing entities is 2.55% (or 0.0255), the annual property tax would be:
Taxable Value: $1,000,000
Combined Tax Rate: 2.55% (0.0255)
Annual Property Tax: $1,000,000 × 0.0255 = $25,500
Note that these local tax rates can vary significantly based on the property's location and local tax rates for school districts, community colleges, and city infrastructure.
Primary Factors Influencing Commercial Property Taxes
Beyond the assessed value and set property tax rates, several factors often influence the amount of property tax levied on commercial properties.
Property location: Properties in areas with higher demand or prime locations may have higher assessed values, leading to increased property taxes.
Property use and zoning: A property's designated use and zoning classification can impact its assessed value and applicable tax rates.
Local government policies: Municipal budgetary requirements and tax policies, including exemptions or incentives for certain types of properties or businesses, can affect property tax obligations. For example, a municipality may offer tax abatements to attract new businesses or encourage development in specific areas.
Commercial vs. Residential Property Taxes
Commercial property taxes often differ from residential property taxes in several ways:
Factor | Residential Properties | Commercial Properties |
|---|---|---|
Typically lower, resulting in lower assessed values | Often higher, leading to increased assessed values | |
Tax rates | Often the same for residential and commercial properties | Often the same for residential and commercial properties |
Valuation Methods | Mostly home sales comparison approach | Income, cost, and sales approaches |
Exemptions | Often receive homestead exemptions like primary residence, senior, and disabled veterans exemptions | Agricultural and environmental exemptions, plus local tax incentives |
Strategies to Manage and Reduce Commercial Property Tax Liabilities
Managing commercial property tax liabilities effectively requires proactive planning, detailed analysis, and strategic action.
Below are a few key methods that property owners and investors can implement to reduce their tax burden and ameliorate their real estate investments.
1. Conduct a Thorough Property Tax Assessment Review
Local assessors periodically determine a commercial property’s value, but errors or overvaluations can occur.
Once you receive your property tax assessment or notice of valuation, property owners should first look for discrepancies such as incorrect square footage, misclassified property use, or outdated improvement records.
Then, to file an informal (and likely formal appeal), use the previously mentioned assessment approaches (income, cost, and sales) to create a convincing property tax appeal case showcasing a lower valuation.
2. Utilize a Cost Segregation Study for Depreciation Benefits
A cost segregation study is an IRS-approved strategy that accelerates depreciation deductions by identifying building components that qualify for shorter depreciation periods. This reduces taxable income and can lead to lower overall tax liabilities. Note that cost-segregation studies are primarily used for tax write-offs versus property tax appeals.
Example:
You own a commercial property and the appraisal district notes a high-level condition of the overall property.
However, if you have strong evidence that your property’s parking lot’s condition isn’t “average” but in “fair” or “poor” condition, then that specific aspect would indicate a lower depreciated amount than other components of the property.
3. Take Advantage of Depreciation Deductions
Depreciation deductions are most often used in accounting as tax write-offs. The IRS allows commercial property owners to deduct the costs of wear and tear over its useful life. Two key methods include:
Straight-Line Depreciation: Spread evenly over the property's useful life (again 39 years for commercial real estate).
Bonus Depreciation & Section 179 Expensing: Certain improvements, such as roofing or security systems, may qualify for immediate deductions instead of long-term depreciation.
Note that the 2025 bonus depreciation rate is 40%, but Congress could return it to 100%.
Also, county appraisers’ depreciation methods include a floor where they stop depreciating unless strong evidence indicates the depreciation is inaccurate.
4. Identify Available Tax Exemptions and Incentives
Many local and state governments offer tax abatements, exemptions, or credits to encourage business growth or redevelopment. These may include:
Historic preservation credits for restoring older commercial buildings.
Enterprise zone incentives for investing in economically distressed areas.
Green building tax credits for energy-efficient upgrades.
Researching and applying for these programs can lead to substantial tax savings, particularly when constructing or updating buildings.
5. Work With Property Tax Professionals
Navigating commercial property tax laws can be complex. Hiring a tax professional service like Ownwell can help.
Our proprietary software and local professional tax consultants meticulously analyze assessment reports and leverage all property valuation techniques to achieve the best appeal outcome.
Armed with compelling evidence, we skillfully negotiate directly with your county appraisal district or before assessment review boards to reduce your property valuation, safeguard your investment, and maximize your returns.
Final Takeaways For Commercial Property Owners and Investors
Understanding commercial property taxes is essential for property owners, investors, and businesses involved in commercial real estate.
A comprehensive understanding of commercial property tax calculation methodologies, influencing factors, and liability management strategies enables stakeholders to make judicious decisions that optimize the profitability and sustainability of their real estate investments.
Lastly, using a software and service like Ownwell can help you achieve higher savings on your commercial property taxes and boost your NOI.
On average, our clients receive 31% higher savings than our competitors.
