Table of Contents

• Capital Gain on Commercial Property
• Types of Capital Gains Tax on Commercial Property
• Real Estate Long-term Capital Gains Tax
• Short-Term Capital Gain Tax Rate
• Recapture Tax and Commercial Real Estate
• How To Defer Capital Gains Tax
• State Capital Gains Tax
• Frequently Asked Questions

Capital Gain on Commercial Property

When your commercial property increases in value, this is considered a capital gain. Before investing in a commercial building, having a tax-facing strategy for said property can help you reduce your overall tax liability. 

Maybe you got burned on the sale of your last property and owed a significant tax from the sale – if you don’t want to make that mistake again, you’ve come to the right place. Understanding how capital gains tax on commercial property works can help you maximize your profits, and minimize your taxes owed. 

If you didn’t have a strategy in place before investing and are wondering if now’s the time to sell, this article will help you figure that out.

And finally, if you haven’t yet bought a property but are looking at different investment opportunities, Revolution Realty Capital can help you finance the property that fits into your overall investment and tax strategy.

Types of Capital Gains Tax on Commercial Property 

There are two main types of capital gains tax on commercial property. The first is long-term capital gains tax – typically owed when you own a property for longer than one year. Short-term capital gains tax is the opposite – you pay this tax if you’ve owned the property for less than one year. 

For some, short-term capital gains tax can yield greater benefits than long-term capital gains tax, and vice versa. 

There are also ways to defer capital gains tax if doing so fits your long-term strategy. The sections below include specific tax rates and methods of deferring capital gains tax to help you identify your best options moving forward.

Real Estate Long-term Capital Gains Tax

The maximum capital gain tax most investors will have to pay is 15% However, if your income from the sale of your commercial property exceeds the amount listed in the 15% bracket, you’ll be subject to a higher tax rate of 20%.

Similar to regular income tax, the long-term capital gains tax on commercial property is subject to graduated rates. For example, if you’re single and made $50,000 on the sale of an investment property, the first $41,675 won’t be taxed, but everything above that will be. This means your total tax liability would be $1,248.75 ($8,325 x 15%).

Short-Term Capital Gain Tax Rate

Short-term capital gains (assets held for less than one year) are subject to ordinary income tax. The table below shows the tax brackets for 2023. Be sure to include both the profit you made from the sale and all income earned from other sources.

Both long- and short-term capital gains tax rates are fairly straight-forward. However, there’s still one more federal tax liability to uncover. 

Recapture Tax and Commercial Real Estate

Because all commercial properties experience depreciation in one form or another, one particular benefit of being a commercial real estate investor is the ability to reduce taxable income by claiming capital depreciation. 

Unfortunately, at the sale of the commercial property, you’ll essentially pay back all of the depreciation you’ve deducted. This is called the recapture tax. It’s important to also note that because the depreciation was deducted from your ordinary income, gains in assets you’ve sold will have to be reported as ordinary income rather than capital gains.

How To Defer Capital Gains Tax

If capital gains tax doesn’t fit well in your tax strategy upon the sale of your commercial property, or you just failed to plan for it, there are ways to defer the tax to a later date. 

One of the most common ways to postpone this tax is by utilizing a 1031 exchange. Another, perhaps less common method is to take part in the opportunity zones program. Before jumping into either strategy, you should consult a tax professional to learn how these options could impact your overall investment strategy. 

1031 Exchange and Capital Gains Tax

A 1031 exchange allows investors to reinvest income from the sale of a property into the purchase of a similar property. You’re essentially rolling over your earnings to let them grow further before eventually paying capital gains tax on them. 

The key to a 1031 exchange is to find a property that’s similar enough to the one you’re selling. This is often required in a short period of time, adding a bit of complexity to the process. There are also different types of 1031 exchanges, so do your research thoroughly before deciding to go this route. 

Opportunity Zones and Capital Gains Tax

Many low-income regions across the United States have been designated as “opportunity zones.” Investing in a qualified opportunity zone allows you to defer paying capital gains tax. Depending on how long you invest in an opportunity zone, you may even receive discounts or full exemptions for capital gains tax on commercial property. 

State Capital Gains Tax

In addition to federal capital gains tax, you’ll also likely have to pay some sort of state capital gains tax on commercial property, although this differs by state. Currently there are only eight states that don’t currently tax capital gains: Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, and Wyoming. 

The other 42 states have varying capital gains tax rates. The lowest as of 2022 was 2.9%, while the highest was 13.3%, with most states taxing capital gains as ordinary income.

Frequently Asked Questions

Understanding how capital gains tax on commercial property works may take some time, so we’ve included a few of the most frequently asked questions below to help you better familiarize yourself. 

How is capital gains tax calculated?

Capital gains tax is calculated based on how long you held the asset, as well as either the amount you gained from the sale of the asset or your ordinary income. If you held the asset for longer than one year, you’ll be taxed either 15% or 20%, or maybe not at all. If you held the asset shorter than one year, your gains from the sale will be factored into your ordinary income tax. 

At what age do you not pay capital gains?

No matter your age, you will have to pay capital gains tax. Prior to 1997, there was a capital gains tax exemption for those over 55 years old. However, the tax code was amended in the late 90s, making this exemption null. 

How can I legally avoid capital gains tax?

You can legally avoid capital gains tax by utilizing section 1031 to defer said tax, converting the investment property to your primary residence, using tax harvesting, or buying the property with a retirement account. 

Before moving forward with any of these options, it’s best to talk with a tax professional who can better inform you of the nuances of each. 

Can I avoid capital gains tax by reinvesting?

Although this is mainly a deferral strategy, you can utilize a 1031 exchange to postpone taxes owed for the time being. If you reinvest your funds in an opportunity zone, you may be able to completely eliminate capital gains tax – depending on how long you hold the property. 

Capital gains tax on commercial property is one of the biggest considerations to make before buying or selling any given property or investing in a real estate fund. If you’ve already consulted a trusted financial advisor and have a tax strategy in place, contact Revolution Realty Capital today to take the next step and finance your commercial property.