Real Estate Law Firm NY Guide to Real Estate Tax Planning Strategies

Your adjusted basis in the property determines depreciation deductions and recapture exposure. When you purchase a building, the purchase price is allocated between land (non-depreciable) and improvements (depreciable). This allocation is not always obvious. A cost segregation study, performed by engineers and tax specialists, breaks down the building into components and assigns shorter useful lives to certain assets, accelerating deductions. The IRS scrutinizes these studies, and aggressive allocations trigger audits. In our experience, the IRS challenges cost segregation claims on roughly 15 to 20 percent of returns selected for examination when the study is not thoroughly documented.

New York does not conform to federal depreciation recapture treatment on all property types. State capital gains tax, which applies to gains over $1 million, compounds federal recapture liability. When you sell a commercial property in New York after holding it five years and claiming $400,000 in depreciation, you owe 25 percent federal recapture ($100,000), plus state tax on the full gain. This is where disputes most frequently arise between taxpayers and their accountants, because the combined state and federal recapture rate can exceed 35 percent.

The 45-day identification window is the most dangerous phase. You may identify up to three replacement properties without limit, or more than three if their aggregate value does not exceed 200 percent of the relinquished property value. Many owners identify properties hastily and then discover structural or title issues that prevent closing. Once the 45-day window closes, you cannot add new properties to your list. In Queens County Supreme Court, disputes over whether a written identification notice was timely delivered often turn on email timestamps and courier records; courts do not grant extensions based on good faith efforts.

You must use a qualified intermediary to hold the sale proceeds. The intermediary cannot be your agent, attorney, accountant, or related party. If you receive the funds directly, even for one day, the exchange fails and you owe tax immediately. Ensure your intermediary has errors and omissions insurance and maintains a compliance checklist for your transaction.

When a partnership or LLC owns real estate, depreciation flows through to individual partners on Schedule K-1. Each partner's basis in the partnership interest increases or decreases based on partnership income, losses, and distributions. If a partner receives a distribution exceeding their basis, that excess is taxable gain. Partners often misunderstand basis tracking and face unexpected tax bills when they receive distributions they believed were tax-free. Maintaining detailed basis records from year one prevents disputes with the IRS and your co-owners.

New York imposes a franchise tax on partnerships and LLCs doing business in the state, calculated as a percentage of gross income or net income, whichever is higher. The franchise tax floor is $25 annually; the ceiling depends on entity classification and income. For real estate holding companies, this tax can be substantial and is not always offset by federal deductions. New York courts in the Department of Taxation and Finance have held that passive real estate holding companies cannot avoid the franchise tax by claiming they are not "doing business" in the state; mere ownership of New York property triggers the tax obligation. This distinction matters when structuring multi-state real estate portfolios.

Repairs are immediately deductible; capital improvements are capitalized and depreciated over time. The IRS frequently disputes this classification, particularly when a property undergoes major renovation. The regulations use a facts-and-circumstances test; no bright-line rule exists. A $50,000 roof replacement is likely a capital improvement. A $5,000 roof repair is likely deductible. The gray zone is where audits occur. Maintain detailed records of each repair, the materials used, and the work performed. Photographs and contractor invoices are critical evidence if the IRS challenges your classification.

If you are purchasing or selling industrial property, tax planning must account for environmental liability, zoning compliance, and lease structures. Industrial real estate transactions often involve deferred maintenance, environmental remediation costs, and specialized depreciation schedules. A cost segregation study on an industrial property may identify machinery and equipment with five-year or seven-year recovery periods, accelerating deductions compared to standard 27.5-year residential or 39-year commercial building depreciation.

When a property owner dies, their heirs inherit the property at a stepped-up basis equal to fair market value on the date of death. This eliminates all accumulated depreciation recapture for the decedent. If your parent purchased a building in 1990 for $500,000 and claimed $300,000 in depreciation over 30 years, reducing their basis to $200,000, the property is worth $1.2 million at their death, and your basis is $1.2 million, not $200,000. The $1 million unrealized gain is erased. This is one of the most significant tax benefits in the U.S. .ax code. Timing the sale of appreciated real estate before or after death can mean the difference between $200,000 and zero in recapture tax.

When you acquire land for development, construction financing and permanent financing are taxed differently. Interest paid during construction is capitalized; interest paid after the property is placed in service may be deductible. Loan points, origination fees, and appraisal costs are also treated differently depending on the timing and purpose of the loan. Real estate development financing structures often involve mezzanine debt, preferred equity, and tax credit syndication. Each layer has distinct tax consequences for the borrower and the lender. Coordinating the financing structure with your depreciation and entity strategy requires early consultation with both counsel and your tax advisor.

Real estate tax planning requires a long-term perspective and coordination across multiple disciplines. The decisions you make today at acquisition affect your recapture liability at sale, your heirs' basis at death, and your compliance exposure with the IRS. Begin planning before you close on the property, not after. If you are considering a significant acquisition, development project, or disposition, discuss your tax strategy with counsel and your accountant together. The overlap between legal structure and tax treatment is where most planning opportunities, and most mistakes, occur.