By: Kelly Smith | 02/18/26
The commercial and investment real estate market is heading into 2026 with a familiar mix of pressure and possibility. Slower transaction volume, higher financing costs, and tighter scrutiny from tax authorities are converging at the same time investors are being pushed to operate with better data, cleaner structures, and tighter compliance. Accounting and tax decisions that once felt routine now carry real financial and audit risk. What follows is a practical look at the most significant real estate tax and accounting issues owners, developers, and investors are likely to face in 2026, and why they matter more than ever.
Key Takeaways
• Accurate partnership capital account maintenance under IRC Section 704(b) is becoming a focal point in IRS examinations, especially for complex real estate partnerships.
• Cost segregation, depreciation planning, and qualified improvement property decisions remain effective ways to reduce current taxable income and preserve after-tax cash flow in a higher interest rate environment.
• Multi state ownership creates growing exposure to income, franchise, and withholding taxes as states expand economic nexus standards and enforcement efforts.
• Revenue recognition errors under ASC 606 remain common for developers, particularly around deposits, construction in progress, and project completion timing.
• FIRPTA withholding, property tax appeals, and exchange compliance failures are increasingly expensive mistakes as audit activity accelerates in 2026.
Partnerships remain the dominant structure for real estate ownership, but they also create one of the most persistent compliance risks. IRC Section 704(b) requires partnerships to maintain capital accounts that reflect the economic deal among partners. In real estate entities, this means accurately tracking cash and property contributions, debt allocations, distributions, and the allocation of income, gain, loss, and deduction.
The most common errors arise when capital accounts are treated as bookkeeping afterthought instead of a governing framework. Contributions of appreciated property are often booked incorrectly on a tax basis instead of fair market value. Distributions tied to refinancing proceeds are sometimes treated as returns of capital without considering minimum gain or partner deficit restoration obligations. Allocations of depreciation and operating losses are frequently made without testing whether they have substantial economic effect.
These errors tend to compound over time. By the time a property is sold or refinanced, capital accounts no longer reconcile to the actual economics of the deal. That is when problems surface, often during a sale transaction or IRS examination. Partners may discover unexpected taxable gain, disputes over waterfall distributions, or challenges reconciling the Partners’ Capital Account Statement to the partnership agreement.
Non compliance with Section 704(b) can result in the IRS reallocating income and loss in ways that do not align with investor expectations. For funds and syndications, this can also undermine investor confidence and complicate capital raising. As audit activity increases in 2026, clean capital account maintenance is becoming foundational to sound real estate accounting and taxation.
Depreciation remains one of the most powerful tax-planning tools available to real estate owners, especially as borrowing costs stay elevated. Cost segregation studies allow owners to identify components of a building that qualify for shorter recovery periods — such as 5, 7, or 15 years, instead of the standard 27.5 (residential rental) or 39 (commercial) years.
For commercial and residential rental properties, properly executed cost segregation can significantly accelerate depreciation deductions in the early years of ownership, materially improving cash flow, particularly valuable when interest expense and operating costs are under pressure.
Under current law, 100% bonus depreciation has been permanently restored for qualified property acquired and placed in service after January 19, 2025, which allows owners to immediately expense the full cost of shorter-lived assets identified in a cost segregation study. This full expensing significantly enhances the benefits of cost segregation relative to the earlier phased-down bonus rules.
Qualified improvement property (QIP) continues to be another area where mistakes are common. Interior improvements to nonresidential buildings, such as interior partitions, certain electrical work, or built-in fixtures, can qualify as 15-year property eligible for both accelerated depreciation and 100% bonus depreciation, but only if properly classified and documented. Misclassification can result in slower depreciation or lost deductions.
Depreciation strategy should also be closely tied to long-term planning. While accelerated depreciation (especially with 100% bonus depreciation) reduces current tax liability and boosts cash flow, it lowers your tax basis, which can increase gain on sale due to depreciation recapture. In a market where pricing risk and refinancing uncertainty remain high, depreciation decisions should be evaluated alongside exit timing, projected Real Estate Interest Rates, and overall investment horizon
Owning property across state lines has never been simple, but it is becoming more complex each year. States continue to expand economic nexus standards, asserting income tax, franchise tax, and withholding obligations even when owners have no physical presence beyond the property itself.
Income tax filing requirements can vary widely. Some states source rental income based solely on property location, while others apply apportionment formulas that factor in receipts, payroll, and property. Deduction limitations, interest expense addbacks, and state specific depreciation rules further complicate compliance.
Identifying nexus triggers is the first challenge. These can include owning property, receiving rental income, having property management activities conducted in state, or participating in development projects. Once nexus is established, ongoing compliance requires careful coordination of filings, payments, and estimated taxes across jurisdictions.
Multi state complexity also affects real estate investors who rely on pass through income reporting. Inconsistent reporting can lead to notices, penalties, and extended audit cycles. As states look for revenue in a slower transaction environment, enforcement activity is expected to remain strong throughout 2026.
Revenue recognition under ASC 606 continues to be a problem area for real estate developers. The standard involves a 5 step analysis one of which requires revenue to be recognized as underlying performance obligations of the developer are satisfied, which often times may not align with when the developer is entitled to receive cash payments under a development agreement . This misalignment may cause differences in the timing of revenue recognition under 606.
Errors in revenue recognition can distort financial statements, complicate lender reporting, and create problems during due diligence for refinancing or sale. In a market where access to capital is tighter, accurate accounting for real estate development activity is critical to maintaining credibility with lenders and investors.
Section 1031 like kind exchanges remain a valuable deferral tool, but they are unforgiving when executed incorrectly. The rules are precise, and even small missteps can disqualify an exchange entirely.
The timing requirements are well known but frequently missed. Replacement property must be identified within 45 days of sale, and the exchange must be completed within 180 days. Identification rules are strict, and failure to follow them precisely can invalidate the transaction.
The role of the qualified intermediary is another common source of error. Funds must never be received or controlled by the taxpayer. Even temporary access to proceeds can trigger immediate tax recognition. Related party transactions and improper use of exchange funds are also frequent pitfalls.
In 2026, with transaction volumes lower and pricing gaps wider, investors are often trying to be creative with exchange structures. That creativity must be balanced with compliance discipline. Proper planning and documentation are essential to preserving tax deferral opportunities.
The Foreign Investment in Real Property Tax Act (FIRPTA) imposes withholding obligations when U.S. real property interests are sold by foreign persons. Buyers are required to withhold a percentage of the gross sales price and remit it to the IRS, regardless of whether the seller actually owes tax.
The standard withholding rate is generally 15 percent, but exemptions and reductions may apply. These include situations where the property will be used as a residence or where the seller obtains a withholding certificate demonstrating a lower expected tax liability.
Failure to comply with FIRPTA can expose buyers to significant liability, including penalties and interest. In a market where foreign investment remains cautious but active, FIRPTA compliance should be addressed early in the transaction process rather than treated as a closing formality.
Property taxes continue to be a significant expense for real estate owners, particularly as local governments seek revenue stability. Assessments often lag market conditions, resulting in taxable values that exceed current fair market value.
Challenging an assessment requires preparation and timing. Owners must gather comparable sales data, income and expense information, and in some cases professional valuations to support a reduction request. Appeals must be filed within statutory deadlines, which vary by jurisdiction and are strictly enforced.
Successful appeals can produce meaningful savings, especially for income producing properties. In an environment where operating margins are under pressure, property tax management is becoming an essential component of overall real estate accounting services.
What are the biggest tax challenges for multi state real estate investors?
Multi state investors face overlapping filing obligations, inconsistent sourcing rules, and varying deduction limitations. Economic nexus standards can trigger tax filings even without employees. Managing compliance across jurisdictions while avoiding double taxation is one of the most persistent challenges for owners in 2026.
How can cost segregation studies reduce my property tax liability?
Cost segregation primarily affects income tax depreciation rather than property tax assessments. However, detailed asset breakdowns can sometimes support arguments that certain components should be excluded from assessed value, indirectly helping manage overall tax exposure when paired with Business Valuation Strategies.
What partnership accounting errors commonly trigger IRS audits?
Common triggers include inconsistent capital account balances, improper allocation of losses, failure to track partner contributions accurately, and discrepancies between tax returns and the partnership agreement. These issues often surface during audits focused on accounting for partnerships and funds.
When should real estate developers recognize revenue ?
Revenue should be recognized as performance obligations are satisfied, either over time or at a specific point in time based on the nature of the agreement.
How do like-kind exchanges work for investment properties?
Like-kind exchanges allow investors to defer gain by reinvesting proceeds into qualifying replacement property. Strict timing rules apply, including a 45 day identification period and a 180 day completion window. Funds must be held by a qualified intermediary to maintain deferral eligibility.
Closing Thoughts
The real estate industry is entering 2026 with more scrutiny, more data, and less margin for error. From capital account compliance to depreciation planning and multistate reporting, the technical details matter. Strong accounting for real estate investors is no longer just about compliance. It is about preserving value, supporting financing, and avoiding surprises when markets shift.
In this environment, disciplined processes, thoughtful planning, and integrated real estate accounting that supports decision making are essential. They help investors maintain transparency, respond to lender and investor expectations, and stay prepared for regulatory changes.
That is why many firms are taking a closer look at real estate accounting outsourcing. Outsourcing can provide access to specialized expertise, scalable support, and consistent processes while allowing internal teams to focus on strategy and growth. For organizations managing complexity across properties and jurisdictions, the right outsourcing support can strengthen accuracy, efficiency, and confidence in financial reporting.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Kelly Smith, partner in Bennett Thrasher’s tax practice practice or Rick Suid, partner in Bennett Thrasher’s Financial Reporting & Assurance practice. Or call us at 770.396.2200.
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