Real Estate Tax Calc
Worked example: full numbers from land purchase to year-10 sale
An investor acquires a 1.2-acre commercial parcel for $400,000 and constructs a 4,500-sq-ft single-tenant restaurant build-to-suit. A national chain tenant signs a 15-year NNN lease at $96,000/year base rent before construction begins — the signed lease de-risks the project and supports construction financing. Total construction costs come to $850,000, broken down as follows:
| Cost component | Amount | Treatment |
|---|---|---|
| Land | $400,000 | Non-depreciable |
| Direct construction costs (materials, labor) | $750,000 | Capitalized — depreciable basis |
| Architect, engineering, and permitting fees | $40,000 | Capitalized — depreciable basis |
| Construction-period interest (capitalized under UNICAP) | $60,000 | Capitalized — depreciable basis (not a current deduction) |
| Total building depreciable basis | $850,000 | 39-year MACRS (or accelerated via cost seg) |
| Total project cost | $1,250,000 | Land $400,000 + Building $850,000 |
The building is placed in service on December 15, 2026. Under the mid-month convention, a December placed-in-service date earns only half a month's depreciation in year one — the smallest possible first-year allocation for the 39-year component. A cost segregation study identifies $170,000 of 5-year property (specialized electrical, tenant-specified HVAC distribution, exterior signage) within the building costs, leaving $680,000 as 39-year nonresidential real property.
| Item | Amount | Notes |
|---|---|---|
| NNN base rent income | $96,000 | Tenant pays property tax, insurance, maintenance directly |
| Bonus depreciation — 5-year cost-seg components | ($170,000) | 100% first-year write-off; property placed in service after Jan. 19, 2025 |
| 39-year MACRS — $680,000 ÷ 39 × (0.5/12) | ($727) | December mid-month: only 0.5 of 1 month's depreciation |
| Management fees and owner-paid insurance | ($4,000) | Other allowable rental deductions |
| Year-1 net taxable income (loss) | ($78,727) | Passive loss — suspends unless passive income exists or REPS qualifies |
The property generates $96,000 of real cash rent yet shows a $78,727 paper loss for tax purposes — driven entirely by the upfront cost-segregation deduction. That suspended passive loss carries forward and offsets future passive income, or is released when the property is eventually sold in a fully taxable transaction.
Year-10 sale at $1,500,000 — gain calculation: After 10 years, accumulated 39-year depreciation on the $850,000 building (using the full rate for simplicity) is approximately $174,000 ($21,795/yr × ~8 full years plus partial years). The 5-year cost-seg components ($170,000) are fully depreciated within years 1–5. Adjusted basis at sale: $1,250,000 − $174,000 − $170,000 = $906,000. Amount realized: $1,500,000. Total gain: $594,000, taxed in three layers:
- §1245 recapture on 5-year cost-seg components: up to $170,000 at ordinary income rates.
- Unrecaptured §1250 gain on the 39-year building: up to $174,000 at a 25% federal maximum rate.
- §1231 gain on the remaining appreciation: $250,000 at long-term capital gains rates (0%, 15%, or 20% depending on taxable income).
All three layers can be deferred in a 1031 exchange into qualifying like-kind replacement property within 180 days of closing.
How basis is established in a build-to-suit project
Unlike buying an existing commercial building — where the purchase price must be allocated between land and improvements using a comparable-sales analysis or appraisal — a build-to-suit project produces a naturally clean basis calculation. Land cost and building cost are tracked separately from day one.
The building's depreciable basis under IRC §263(a) equals the sum of all capitalized construction costs:
- Direct materials and labor paid to contractors and subcontractors
- Architect, structural engineering, MEP engineering, and design fees
- Building permits and development impact fees
- Survey costs allocated to the building (not to raw land)
- Construction-period interest required to be capitalized under UNICAP (see below)
Costs that are not capitalized into the building's basis include: post-placed-in-service operating expenses (deducted as incurred), loan origination fees and mortgage points (amortized under §461 over the loan term), and any tenant improvement allowance paid directly to the tenant after the lease commences (a TIA is a separate transaction with its own tax treatment).
Once the building is placed in service, the basis is fixed. No reallocation between land and building is needed after the fact, which simplifies audit defense and eliminates the often-contentious land-value estimates that arise when buying an existing property in a hot market.
Depreciation of the purpose-built building
The 39-year shell depreciates using MACRS straight-line under the mid-month convention. The annual depreciation rate on a full year of service is 1/39 of the building's basis. The placed-in-service month determines the fraction of the first year's depreciation: a building placed in service in January earns 11.5/12 of one year's depreciation; a building placed in service in December earns only 0.5/12 — the minimum.
The difference matters for year-1 planning. A developer who can accelerate a December completion to a November placed-in-service date increases the first-year 39-year deduction from $727 to roughly $1,454 on an $850,000 building — small in absolute terms but meaningful when combined with cost-seg timing.
What moves the needle is cost segregation. A purpose-built restaurant or retail build-to-suit often carries a higher proportion of cost-seg-eligible components than a standard commercial office building, because every element was specified by the tenant for a specific use:
- Specialized HVAC distribution and exhaust systems (5-year)
- Tenant-specified electrical panels and wiring (5-year)
- Exterior and monument signage (15-year)
- Parking lot, curb cuts, and site lighting (15-year land improvements)
- Built-in display fixtures and millwork (7-year)
NNN lease income during the operating phase
Once the tenant takes occupancy, the tax treatment of operating income follows the same rules as any triple net property. Base rent is ordinary gross rental income, reported on Schedule E (or the entity return). Because the tenant pays property taxes, building insurance, and maintenance directly to the third-party vendors, the landlord neither reports those payments as income nor deducts them as expenses — they never flow through the landlord's books.
In the first several years after a cost-segregation study, the annual depreciation on the 39-year remaining basis ($680,000 ÷ 39 = $17,436/year) is typically modest relative to rent — the big first-year deduction came from the 100% bonus on the reclassified short-life components. Net taxable income from the property in years 2–10 will roughly be: $96,000 rent − $17,436 depreciation − overhead = approximately $70,000–$75,000 of passive income per year, which helps absorb any suspended passive losses carried from other properties.
The long lease term — 15 years in this example — provides predictable income with no re-leasing risk during that period. Single-tenant NNN properties are often valued on a cap-rate basis reflecting the tenant's credit quality, so a property leased to a national chain at a low cap rate can appreciate meaningfully over the hold period even if the rent is flat.
Passive activity rules and the QBI deduction
A build-to-suit NNN investment is a passive rental activity by default under IRC §469. This means:
- Losses (including year-1 cost-seg losses) are passive and can only offset passive income from other rental activities or other passive investments — not wages or business income.
- Passive losses in excess of passive income suspend and carry forward indefinitely.
- Suspended passive losses are released in full when the property is sold in a fully taxable transaction.
Investors who qualify as real estate professionals (more than 750 hours in real property trades and more than half their total work time in real estate) and who materially participate in managing the property can treat rental losses as non-passive — allowing the year-1 cost-seg deduction to offset other income directly. For a pure NNN investor who does nothing but collect rent, material participation in a triple net property is very difficult to establish.
On the QBI deduction (IRC §199A), the story is familiar from the standard NNN analysis. The IRS safe harbor for rental real estate (Notice 2019-07) explicitly excludes properties subject to triple net leases, so a build-to-suit NNN investor cannot rely on the safe harbor. Qualifying requires establishing trade-or-business status on the facts — a tougher standard for a fully passive single-tenant hold than for an actively managed portfolio. If you NNN-lease the build-to-suit to your own operating business, the self-rental rules allow QBI to pass through as part of the common-ownership group.
Disposition: 1031 exchange and gain calculation
At sale, the investor's gain is calculated as: amount realized minus adjusted basis. Adjusted basis = original total basis ($1,250,000) minus all depreciation claimed (39-year building depreciation + cost-seg component depreciation).
Using the year-10 sale scenario above ($1,500,000 sale price, ~$344,000 total accumulated depreciation): adjusted basis is $906,000, producing a total gain of $594,000. That gain is not taxed at a single rate — it is split into three layers by type:
| Gain layer | Amount | Federal tax rate |
|---|---|---|
| §1245 recapture — 5-year cost-seg depreciation | $170,000 | Ordinary income rates (up to 37%) |
| Unrecaptured §1250 — 39-year building depreciation | $174,000 | Maximum 25% federal rate |
| §1231 gain — remaining appreciation | $250,000 | Long-term capital gains rates (0%, 15%, or 20%) |
| Total gain | $594,000 | Also subject to 3.8% NIIT if applicable |
A 1031 exchange defers all three gain layers by rolling the proceeds into qualifying like-kind replacement property within 180 days of closing. The deferred gain reduces the replacement property's basis, so recapture and appreciation gain resurface only when the replacement property is eventually sold in a taxable transaction — or can be deferred again in a subsequent 1031 exchange.
Build-to-suit vs. buying an existing NNN: tax comparison
Both routes produce a single-tenant NNN asset, but the tax mechanics differ in a few important ways:
| Factor | Buy existing NNN | Build-to-suit NNN |
|---|---|---|
| Building basis source | Allocated purchase price (appraisal or cost approach) | Actual construction costs (direct + architect + UNICAP interest) |
| Land allocation | Estimated; can be disputed by IRS | Exact (land purchase tracked separately) |
| Year-1 depreciation on building | 39-year SL from placed-in-service date + prior cost-seg study if done | 39-year SL + 100% bonus on new cost-seg study; often larger deduction |
| Construction-period interest | N/A — acquisition financing interest deducted currently | Must be capitalized under UNICAP if >12-month build |
| Income during development | Rental income begins immediately at close | No income during construction period |
| Lease status at acquisition | Lease already running; remaining term may be short | Fresh 15-20 year lease; full term ahead |
State tax and multi-state compliance
Rental income from a build-to-suit property is sourced to the state where the building is located. If you are a resident of one state and the property is in another, you generally owe a nonresident income tax return in the property's state, with your home state granting a credit for taxes paid to avoid double taxation.
Several state-level issues are worth flagging for build-to-suit NNN owners:
- Bonus depreciation conformity: Many states do not conform to federal 100% bonus depreciation. California, for example, requires adding back the federal bonus and recovering the deduction on its own 5-year schedule. The year-1 paper loss that fully offset federal passive income may only partially offset state income.
- Construction sales tax: Materials purchased during construction are typically subject to state sales or use tax, and that tax is a capitalized cost (added to building basis), not a deductible expense. Some states offer sales tax exemptions for certain commercial construction materials — check state law before budgeting.
- Nonresident withholding: Some states require the tenant or a designated agent to withhold a percentage of rent paid to nonresident landlords and remit it to the state tax authority. The withheld amount is a credit against your nonresident state return, not an additional cost.
- Multi-state portfolio: A developer who builds multiple NNN properties in different states faces growing state compliance costs — a recurring expense that should be factored into projected yields before committing capital.
Frequently asked questions
Can I deduct construction-period interest on a build-to-suit project?
Not immediately. Under IRC §263A (UNICAP), construction-period interest on a building that takes more than 12 months to complete and costs more than $1 million must be capitalized into the building's basis rather than deducted in the year paid. The interest is then recovered through 39-year straight-line depreciation rather than as a current deduction.
How do I establish the building's depreciable basis in a build-to-suit?
The building's depreciable basis equals all capitalized construction costs: direct materials and labor, architect and engineering fees, permitting, and construction-period interest required to be capitalized under IRC §263A. Land is excluded and kept as a separate non-depreciable asset. Unlike buying an existing building, there is no allocation required between land and structure — you simply track actual land cost and actual construction cost separately.
When does a build-to-suit NNN building start depreciating?
Depreciation begins when the building is placed in service — meaning it is in a condition and state of readiness to be used for its intended purpose. For a build-to-suit, that is typically the date the tenant takes occupancy and the lease commences, or the date construction is substantially complete, whichever is earlier. The placed-in-service date anchors the mid-month convention calculation for year-1 depreciation.
Is a build-to-suit first-year cost-segregation loss deductible right away?
Only if you have enough passive income or qualify as a real estate professional who materially participates. A build-to-suit NNN lease is a passive rental activity by default under IRC §469. A large year-1 cost-segregation loss exceeding rental income is a passive loss, which suspends and carries forward until offset by passive income from other sources or when the property is sold in a fully taxable transaction.
How is the gain on a build-to-suit NNN sale taxed?
Gain is split three ways. Depreciation claimed on 5-year cost-segregation components is recaptured as ordinary income under IRC §1245. Depreciation claimed on the 39-year building is unrecaptured §1250 gain taxed at a maximum federal rate of 25%. Any remaining gain above your adjusted basis that is not recaptured depreciation is §1231 gain, taxed at long-term capital gains rates. A 1031 exchange can defer all three layers of gain if you reinvest into qualifying like-kind replacement property within 180 days.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.