Real Estate Tax Strategies for Hotel Investors

Tax strategy is a critical component of successful hotel investing. Unlike other real estate investments, hotels operate as both real estate assets and active businesses, creating unique tax planning opportunities and challenges.

Properly structuring an investment, taking advantage of available deductions throughout your ownership, and planning for tax-efficient exits can significantly impact your bottom line. Whether you’re acquiring a new property, looking to optimize the operations of an existing asset or considering an exit strategy, understanding real estate tax strategies for hotel investors is key to maximizing profitability and cash flow.

Tax strategy plays a role at every stage of a hotel investment. The entity you choose to hold the hotel (and the operating business) within has major tax and operational implications throughout your ownership. During the ownership, hotel investors should seek to leverage tax credits and incentives and take advantage of depreciation opportunities, while keeping their sales and use tax commitments in mind. And when it comes time to exit the investment, the structure of the sale, plus the actions you choose to take thereafter, can have a significant impact on your tax strategy.

At James Moore, our real estate tax professionals have significant experience advising hotel investors and operators. In this guide to real estate tax strategies for hotel investors, we’ll walk you through the factors you have to consider in each of the areas outlined above, giving you the insights you need to manage your hotel in a tax-efficient manner.

Choosing the Right Business Structure for Tax Efficiency

For hotel investors, partnerships are typically the most common and advantageous business structure. This is because partnerships offer pass-through taxation, meaning profits and losses are reported on the individual partners’ tax returns — avoiding the double taxation corporations face. Additionally, partnerships permit special allocations, which provide flexibility in how income and expenses are allocated among partners.

A key complexity in hotel investments is that they often involve two separate entities: one for holding the real estate, and another for operating the hotel business itself. This structure allows investors to separate the ownership of the physical property from the management and operation of the hotel itself. The real estate entity leases the property to the operating entity, which runs the day-to-day business. This setup can provide several advantages, including:

• Liability protection: Shields real estate investors from operational liabilities related to hotel management.
• Tax efficiency: Allows the operating entity to deduct rental expenses paid to the real estate entity, while the real estate entity benefits from depreciation deductions.
• Financing flexibility: Enables separate financing structures for property acquisition and business operations, often leading to more favorable loan terms.

Within a partnership structure, investors can take advantage of special allocations that allow for tax-efficient distribution of depreciation benefits, financing deductions and other tax incentives. It’s important, however, to consider the impact this may have on investors’ basis limitations and passive activity loss limitations.

Given the complexity at play here, working with an experienced tax advisor is crucial to optimizing the tax benefits of hotel investments. If you have questions about the optimal entity structure to use for a hotel investment, the team at James Moore is here to help.

Read More: Partnership vs. S Corp: What’s Best for Holding Property?

Maximizing Depreciation with Cost Segregation Studies

Depreciation is one of the most valuable tax tools available to all real estate investors, allowing them to reduce taxable income by accounting for the wear and tear of the property. However, instead of using standard depreciation schedules, investors can accelerate deductions through cost segregation studies.

A cost segregation study identifies specific components of a hotel property — such as lighting, HVAC systems, and flooring — that are eligible to be depreciated on a quicker timeline than the standard 39-year depreciation schedule. By classifying these components into shorter depreciation categories (5, 7 or 15 years, depending on the building component), investors can front-load depreciation expenses, leading to significant tax savings in the early years of ownership.

There have also been discussions over reinstating 100% bonus depreciation as part of new tax legislation. This previously allowed investors to immediately deduct the full cost of qualifying assets, but currently only allows a 40% deduction in 2025. If reinstated, this provision would further enhance the benefits of cost segregation by allowing hotel investors to take even larger deductions upfront.

Leveraging Tax Credits and Incentives

Hotel investors may be eligible for various tax credits and incentives, particularly when investing in specific types of properties or locations. Some notable opportunities include:

• Historic tax credits: If a hotel is located in a designated historic district or is a certified historic structure, investors may qualify for federal and state tax credits for renovation and preservation efforts. The historic tax credit provides a 20% credit for qualified rehabilitation expenditures, while many states offer additional credits that can be layered on top of the federal incentive. These tax credits can significantly reduce the cost of restoring historic hotels, making such projects financially viable.

• Energy-efficient tax deductions: The federal government offers incentives for energy-efficient hotel renovations and new construction projects. Two key tax incentives include:

• Section 179D Energy-Efficient Commercial Buildings Deduction: This deduction allows hotel owners to claim a tax deduction for installing energy-efficient HVAC systems, lighting, and insulation. The deduction can be up to $5 per square foot, depending on the level of energy savings achieved.

• 45L tax credit for energy-efficient residential units: If a hotel includes extended-stay suites or residential-style accommodations, it may qualify for the 45L tax credit, which provides a per-unit tax credit for energy-efficient construction.

In addition to these federal tax opportunities, there are also plenty of state and local tax incentives. Needless to say, these vary by jurisdiction. Your tax professional can help you determine which opportunities your investment might qualify for.

Interested in learning more? Dig deeper with our guide to construction tax credits.

Sales and Use Tax Considerations for Hotel Investors

Managing a hotel involves more than just real estate taxes. Sales and use taxes can have a significant impact on profitability and compliance obligations.

Hotels are unique in that they generate revenue from multiple streams, including room rentals, food and beverage sales, conference facilities, and ancillary services such as parking or spa treatments. Each of these revenue sources may be subject to different sales tax rules depending on state and local tax laws. Here is a brief overview:

• Sales tax on room rentals: Most states impose a sales or lodging tax on hotel room rentals. The tax rates and exemptions vary by jurisdiction, and some municipalities impose additional tourism taxes. Hotel investors must carefully track and remit these taxes to avoid penalties and audits.
• Food and beverage sales: Restaurants, bars and in-room dining services within hotels are typically subject to sales tax. Properly accounting for and collecting these taxes is essential for compliance.
• Use tax on purchases: Hotels frequently purchase large quantities of supplies, furniture and equipment. When buying from out-of-state vendors who do not charge sales tax, the hotel may be responsible for self-assessing and remitting use tax. Failure to do so can result in unexpected tax liabilities.
• Sales tax exemptions: Some hotel transactions may qualify for exemptions, such as long-term stays exceeding a certain number of days or sales to tax-exempt organizations. Understanding these rules can help hotel operators reduce unnecessary tax burdens.

Given the complexity of sales and use tax compliance in the hospitality industry, hotel investors should work with tax professionals to establish best practices for accurate collection, reporting and remittance of these taxes.

Tax Planning for Exit Strategies

When it comes time to sell a hotel, investors must plan carefully to minimize tax liabilities. Some options include:

• Installment sales: These transactions allow sellers to spread income over multiple years to reduce tax burdens in any given year. Seller financing tends to be more common in the hotel space, giving investors the ability to spread the income from a sale across multiple years.
• 1031 exchanges: Investors may defer the capital gains tax on the sale of their hotel by performing a 1031 exchange into a new asset of equal or greater value. Replacement properties must be identified within 45 days of the sale, and the transaction must be completed within 180 days.

By planning ahead, investors can structure their exits in a way that maximizes returns and allows them to continue to grow the value of their portfolio over the long term.

Partner with James Moore for Expert Real Estate Tax Planning

Hotels present a unique and compelling investment opportunity due to their ability to generate strong returns through operational improvements and value-add strategies. Compared to other classes of real estate, hotel owners have far more levers to actively drive EBITDA growth. Whether it’s through upgrading amenities, implementing cost-saving energy efficiencies or repositioning a property to attract higher-end clientele, the ability for investors to directly influence cash flow makes hotels a particularly attractive investment.

However, with this opportunity comes complexity, particularly in tax planning. Navigating the tax landscape as a hotel investor requires a deep understanding of tax law, depreciation strategies, financing structures and exit planning. At James Moore, our experienced CPAs have worked with hotel investors across the country to develop tailored tax strategies that optimize profitability and compliance.

Whether you’re structuring a new hotel investment, looking to take advantage of tax incentives or planning for a tax-efficient exit, our team is here to help. Contact James Moore today to learn how we can support your business.

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