Navigating the Tax Implications of Intangible Assets in Real Estate

NOTE: Courtney is posting today’s blog on behalf of its author, Kelly McCoy.

When it comes to operating or selling rental real estate, you need to consider the tax consequences of the various intangible assets associated with ownership of that building. Such intangible assets can include lease acquisition fees, lease cancellation fees, and loan origination fees.

First and foremost, it’s essential to determine how these assets are classified for tax purposes and how different scenarios may impact the characterization of related transactions. Understanding how these assets are treated from a tax perspective can help property owners navigate potential tax liabilities and make informed decisions.

Lease acquisition costs

Lease acquisition costs, including items such as brokerage fees, create a benefit lasting the life of the lease requiring amortization of that benefit over the lease period. Various events leading to the termination of a lease produce different tax outcomes.

For instance, if a tenant decides to terminate the lease early, the benefit of this asset no longer exists, and any unamortized asset becomes fully deductible from ordinary income in the year of termination.

However, if the owner is selling the building with the lease still in place, the characterization will be different. In this case, the unamortized balance is being “sold” to the buyer and is considered basis in the building, reducing any capital gain or increasing any capital loss upon the sale of the building.

Lease cancellation fees

Lease cancellation fees paid by a landlord to terminate leases could also have different results, depending on the circumstances. Lease cancellation fees are a capital expenditure, but how the cost is recovered depends on the reason for the termination.

If the landlord is cancelling the lease to reclaim the space for its own use, the cost of that termination would need to be amortized over the remaining life of the cancelled lease. If the landlord is taking the space back to lease to a new tenant, then the cost would need to be amortized over the life of the lease with the new tenant.

Loan costs

Loan origination fees associated with the acquisition of financing the purchase of real estate are required to be capitalized and amortized over the life of the loan. As with so many things, determining what happens to any unamortized balance when a loan is paid off will depend on how that loan was satisfied.

If the mortgage payoff is through refinancing, then it will, yet again, depend on which lender you’re refinancing with. If you’re refinancing with the same lender, you’ll need to amortize the remaining balance of the unamortized loan costs over the life of the new loan. If you refinance with a new lender, you can deduct the remainder of the unamortized mortgage fees in the year of the refinance.

Lastly, if you sell the property and pay off the loan at the time of sale, you can fully deduct the remaining unamortized fees against ordinary income.

How we can help

Understanding the tax consequences of intangible assets for real estate entities is important for property owners looking to enhance their profits and reduce their tax liabilities. Involving our professionals as early as possible can help you develop strategies that may need to be implemented before contracts are entered into. With a deep knowledge of the real estate industry, our professionals can help you navigate these transactions.