What Is Capital Gains Tax on Commercial Real Estate?
Capital gains tax on commercial real estate is the federal and state tax you owe on the profit from selling a commercial property. The IRS calculates your gain as the difference between your adjusted basis (original purchase price plus improvements, minus accumulated depreciation) and your net sale price after closing costs.
For commercial property owners, capital gains taxes represent one of the largest single expenses at the time of sale. A $3 million commercial property purchased for $1.5 million a decade ago could trigger $300,000 or more in combined federal and state capital gains taxes. Understanding how these taxes work, and the legal strategies available to reduce them, directly impacts your net proceeds and reinvestment potential.
Capital Gains Tax at a Glance: Key Federal Rates for Commercial Real Estate
15-20%
Long-Term Capital Gains Rate
25%
Depreciation Recapture Rate
3.8%
Net Investment Income Tax
Up to 37%
Short-Term Capital Gains Rate
Capital gains on commercial real estate fall into three potential tax layers: the standard capital gains rate, depreciation recapture under Section 1250, and the net investment income tax (NIIT). Each layer has its own rate structure and rules. Strategic planning around all three can save investors tens or even hundreds of thousands of dollars on a single transaction.
If you are considering selling a commercial property or planning your next acquisition, understanding these tax obligations before listing is essential for accurate financial modeling.
How Are Capital Gains Calculated on Commercial Property Sales?
Calculating capital gains on commercial real estate requires three key numbers: the original purchase price, your adjusted basis, and the net sale price. The adjusted basis is where most of the complexity lives, because it accounts for improvements, selling costs, and depreciation claimed over the holding period.
Here is the formula:
Capital Gain = Net Sale Price - Adjusted Basis
Your adjusted basis starts with the original purchase price, adds the cost of capital improvements (roof replacements, HVAC upgrades, tenant buildouts), and subtracts the total depreciation claimed or allowable. Even if you never claimed depreciation deductions on your tax returns, the IRS treats the depreciation as "allowed or allowable," meaning you still owe recapture tax on it.
How to Calculate Your Capital Gain on Commercial Property
Start With Purchase Price
Original acquisition cost including closing costs
Add Capital Improvements
Roof, HVAC, buildouts, and structural upgrades
Subtract Depreciation
Total depreciation claimed or allowable over holding period
Determine Adjusted Basis
Purchase price + improvements - depreciation
Calculate Net Sale Price
Gross sale price minus selling costs and commissions
Compute Total Gain
Net sale price minus adjusted basis equals taxable gain
Example Calculation:
You purchased a retail center for $2,000,000 ten years ago. Over that period, you invested $200,000 in capital improvements and claimed $500,000 in depreciation. Your adjusted basis is $2,000,000 + $200,000 - $500,000 = $1,700,000. If you sell for $3,200,000 with $160,000 in selling costs, your net sale price is $3,040,000. Your total gain is $3,040,000 - $1,700,000 = $1,340,000.
That $1,340,000 gain is then split into two portions for tax purposes: the depreciation recapture portion ($500,000 taxed at up to 25%) and the remaining capital gain ($840,000 taxed at your applicable long-term or short-term rate). Use our commercial mortgage calculator to model how reinvestment of sale proceeds could fund your next property.
What Are the Current Capital Gains Tax Rates for 2025 and 2026?
Capital gains tax rates depend on how long you held the property and your taxable income. Properties held for more than one year qualify for long-term capital gains rates, which are significantly lower than short-term rates. Properties held for one year or less are taxed as ordinary income.
2024/2025 Long-Term Capital Gains Tax Brackets (Single Filers)
| Tax Rate | 2024 Income Threshold | 2025 Income Threshold | Typical CRE Investor Impact |
|---|---|---|---|
| 0% | Up to $47,025 | Up to $48,350 | Rarely applies to commercial sellers |
| 15% | $47,026 to $518,900 | $48,351 to $533,400 | Applies to many mid-market investors |
| 20% | Over $518,900 | Over $533,400 | Common for large commercial transactions |
| 25% (Recapture) | All income levels | All income levels | Applies to depreciation portion of gain |
| +3.8% NIIT | MAGI over $200,000 | MAGI over $200,000 | Applies to most commercial investors |
Long-term capital gains rates (properties held over 12 months):
- 0% for single filers earning up to $47,025 (2024) or $48,350 (2025)
- 15% for single filers earning $47,026 to $518,900 (2024) or $48,351 to $533,400 (2025)
- 20% for single filers earning above $518,900 (2024) or above $533,400 (2025)
Most commercial real estate investors fall into the 15% or 20% bracket. However, these rates apply only to the portion of gain above your depreciation recapture amount. The effective combined rate, including depreciation recapture and NIIT, can reach 28.8% or higher before state taxes.
Short-term capital gains rates (properties held 12 months or less):
Short-term gains are taxed at ordinary income rates, ranging from 10% to 37% for 2024 and 2025. Selling within the first year can nearly double the federal tax bill compared to waiting for long-term treatment.
For investors evaluating whether to sell now or hold, the tax rate differential between short-term and long-term treatment on a $1 million gain can exceed $150,000 in federal taxes alone. If your holding period is approaching the 12-month mark, waiting even a few weeks could generate substantial savings.
What Is Depreciation Recapture and How Does Section 1250 Work?
Depreciation recapture is the portion of your capital gain attributable to depreciation deductions you previously claimed (or were entitled to claim) on the property. Under Section 1250 of the Internal Revenue Code, the IRS "recaptures" this tax benefit when you sell by taxing the depreciation amount at a maximum rate of 25%.
Commercial real estate is depreciated over 39 years for nonresidential property and 27.5 years for residential rental property using the straight-line method. Each year of ownership reduces your tax basis, which increases your taxable gain at sale even if the property has not actually appreciated.
Depreciation Recapture by Property Type Over 15-Year Hold (Per $1M Value)
Nonresidential (39-yr)
96,154
Residential Rental (27.5-yr)
136,364
With Cost Segregation
175,000
With Bonus Depreciation
250,000
Why depreciation recapture matters:
On a $5 million office building held for 15 years, you would have claimed approximately $1,923,077 in depreciation ($5,000,000 / 39 years x 15 years). At the 25% recapture rate, that is $480,769 in depreciation recapture tax alone, before any capital gains tax on the property's appreciation.
The key point many investors miss is that depreciation recapture applies even if you did not actually claim depreciation deductions. The IRS uses the "allowed or allowable" standard, meaning you owe recapture tax on the depreciation you could have claimed. Always claim your depreciation deductions, as skipping them provides no tax benefit during ownership while still creating a recapture liability at sale.
Bonus depreciation and cost segregation studies can accelerate depreciation deductions during ownership, providing larger upfront tax benefits. However, these accelerated deductions also increase the recapture amount at sale. Work with a qualified CPA to balance the time value of upfront deductions against the eventual recapture cost. Reach out to our team if you need a referral to a CRE-specialized tax advisor.
What Is the Net Investment Income Tax and Does It Apply to Your Sale?
The Net Investment Income Tax (NIIT) adds an additional 3.8% surtax on investment income, including capital gains from commercial real estate sales, for high-income taxpayers. This tax applies when your modified adjusted gross income (MAGI) exceeds specific thresholds.
Net Investment Income Tax (NIIT): Threshold and Application
| Filing Status | MAGI Threshold | NIIT Rate | Applies To |
|---|---|---|---|
| Married Filing Jointly | $250,000 | 3.8% | Lesser of net investment income or excess MAGI |
| Single / Head of Household | $200,000 | 3.8% | Lesser of net investment income or excess MAGI |
| Married Filing Separately | $125,000 | 3.8% | Lesser of net investment income or excess MAGI |
NIIT thresholds:
- $250,000 for married filing jointly
- $200,000 for single filers
- $125,000 for married filing separately
The 3.8% NIIT applies to the lesser of your net investment income or the amount by which your MAGI exceeds the threshold. For most commercial property investors generating a significant capital gain, the entire gain will be subject to NIIT.
Combined federal tax rates with NIIT:
- Depreciation recapture: 25% + 3.8% = 28.8%
- Long-term capital gains (20% bracket): 20% + 3.8% = 23.8%
- Short-term capital gains (37% bracket): 37% + 3.8% = 40.8%
For a commercial property sale generating $1 million in total gain ($400,000 depreciation recapture and $600,000 appreciation), the combined federal tax bill could reach $257,200 ($115,200 recapture + $142,800 capital gains with NIIT). State taxes would add to this total.
Understanding the NIIT helps investors accurately project after-tax proceeds and evaluate whether refinancing to extract equity might be more tax-efficient than selling outright.
What Strategies Can You Use to Defer or Reduce Capital Gains Tax?
Several legal strategies allow commercial real estate investors to defer, reduce, or eliminate capital gains taxes. The right approach depends on your investment timeline, reinvestment goals, and overall tax situation.
1031 Exchange (Like-Kind Exchange)
The most widely used deferral strategy is the 1031 exchange, which allows you to defer all capital gains taxes by reinvesting sale proceeds into a "like-kind" replacement property. You must identify replacement properties within 45 days and close within 180 days. Both the replacement property price and the equity invested must equal or exceed the relinquished property to achieve full deferral.
Opportunity Zone Investment
Investing sale proceeds into a Qualified Opportunity Zone Fund can provide capital gains deferral and, if held for 10 years or more, permanent exclusion of gains on the new investment. Read our Opportunity Zone investing guide for detailed eligibility requirements.
Installment Sale (Section 453)
An installment sale spreads the gain recognition over multiple tax years by receiving the sale price in payments rather than a lump sum. The gain is recognized proportionally as payments are received, potentially keeping you in lower tax brackets each year.
Charitable Remainder Trust (CRT)
Contributing appreciated property to a CRT before sale can eliminate capital gains tax on the transfer, provide an income stream for the donor, and generate a charitable deduction. The trust sells the property tax-free, reinvests the full proceeds, and distributes income to you over a specified period.
For investors exploring exit strategies for commercial development projects, combining multiple approaches often yields the best tax outcome.
How Do Installment Sales Work for Commercial Real Estate?
An installment sale under IRC Section 453 allows you to spread capital gains recognition across multiple years by structuring the sale with seller financing. Instead of receiving the full purchase price at closing, you receive payments over time and only owe capital gains tax on the profit portion of each payment.
How an Installment Sale Works for Commercial Real Estate
Negotiate Terms
Agree on total price, down payment, interest rate, and payment schedule
Close the Sale
Transfer title and recognize depreciation recapture in Year 1
Receive Annual Payments
Each payment includes principal, gain, and interest portions
Report Proportional Gain
Pay capital gains tax only on the gain portion of each payment
Complete the Schedule
Full gain recognized over the installment period (typically 5 to 15 years)
How it works:
Each installment payment consists of three components: return of basis (tax-free), capital gain (taxed at applicable rate), and interest income (taxed as ordinary income). The "gross profit ratio" determines what percentage of each payment is taxable gain.
Gross Profit Ratio = Total Gain / Contract Price
Example: You sell a $4 million industrial property with an adjusted basis of $2.5 million, creating a $1.5 million gain. Your gross profit ratio is 37.5% ($1.5M / $4M). If you receive $800,000 per year over five years, $300,000 of each payment is taxable gain (37.5% x $800,000), and $500,000 is return of basis.
Benefits: Spreads tax liability across multiple years, can keep you in lower tax brackets, provides a steady income stream with interest, and seller financing often commands a premium sale price.
Limitations: Depreciation recapture must be recognized in Year 1 regardless of payment schedule. Interest rates must meet IRS minimum (Applicable Federal Rate). Buyer default risk exists without adequate collateral.
How Do State Taxes Affect Your Total Capital Gains Liability?
State capital gains taxes add a significant layer to your total tax burden and vary dramatically depending on where you live and where the property is located. Some states tax capital gains at ordinary income rates while others have no income tax at all.
State Capital Gains Tax Rates: Highest and Lowest for Commercial Property
| State | Capital Gains Tax Rate | Treatment | Notes |
|---|---|---|---|
| California | Up to 13.3% | Taxed as ordinary income | Highest state rate in the U.S. |
| New York | Up to 10.9% | Taxed as ordinary income | NYC adds up to 3.88% more |
| New Jersey | Up to 10.75% | Taxed as ordinary income | No preferential capital gains rate |
| Oregon | Up to 9.9% | Taxed as ordinary income | High rate on all income levels |
| Florida | 0% | No state income tax | Major advantage for CRE investors |
| Texas | 0% | No state income tax | Strong market with zero state tax |
| Nevada | 0% | No state income tax | Popular for asset holding entities |
| Wyoming | 0% | No state income tax | Favorable trust and entity laws |
States with no income tax (0% capital gains rate):
Florida, Texas, Nevada, Wyoming, Tennessee, South Dakota, Washington, and Alaska impose no state income tax on capital gains. Investors in these states keep more of their sale proceeds, which can represent savings of 5% to 13% compared to high-tax states.
High-tax states for capital gains:
California taxes capital gains at ordinary income rates up to 13.3%. New York City residents face a combined state and city rate of up to 12.7%. New Jersey, Oregon, and Minnesota all impose rates exceeding 9%.
Key state tax considerations:
The property's location, not just your residence, can determine state tax obligations. If you live in Texas but sell a commercial property in California, you will likely owe California capital gains tax. Some states do not fully conform to federal 1031 exchange rules and may require reporting when the replacement property is located out of state.
Planning your commercial property refinance or sale around state tax implications can save substantial amounts. Contact our team to discuss how financing strategies interact with your tax planning.
What Are Common Mistakes Investors Make With Capital Gains Tax?
Commercial real estate investors frequently make costly errors when managing capital gains taxes. Avoiding these mistakes can save thousands to hundreds of thousands of dollars.
Mistake 1: Not claiming depreciation. Some investors skip depreciation deductions thinking it will reduce their taxable gain at sale. It will not. The IRS recaptures depreciation on the "allowed or allowable" amount. You pay recapture tax whether you claimed the deductions or not.
Mistake 2: Missing 1031 exchange deadlines. The 45-day identification period and 180-day closing deadline are absolute. Missing either deadline by even one day disqualifies the entire exchange, triggering full capital gains tax.
Mistake 3: Ignoring the NIIT. Many investors calculate only the base capital gains rate and are surprised by the additional 3.8% NIIT at tax time. Always include the NIIT if your MAGI exceeds $200,000 (single) or $250,000 (married filing jointly).
Common Capital Gains Tax Mistakes to Avoid
- Not claiming depreciation (you owe recapture tax anyway). 2. Missing 1031 exchange deadlines (45-day and 180-day rules are absolute). 3. Ignoring the 3.8% NIIT surtax in your projections. 4. Selling before the 12-month mark (short-term rates up to 37%). 5. Failing to document capital improvements (reduces your basis). 6. Not modeling state taxes (can add 0% to 13.3% to your bill).
Mistake 4: Selling before the 12-month holding period. Short-term capital gains are taxed at ordinary income rates up to 37%, compared to the maximum 20% long-term rate. On a $500,000 gain, this difference is $85,000 in additional federal taxes.
Mistake 5: Poor basis tracking. Failing to document capital improvements reduces your basis and increases your taxable gain. Keep detailed records of every improvement, including receipts, contracts, and permits.
How Can You Plan Ahead to Minimize Capital Gains Tax Exposure?
Proactive tax planning starts years before you list a commercial property for sale. The decisions you make during ownership directly impact your tax liability at disposition.
During ownership:
Claim all available depreciation deductions every year. Consider a cost segregation study to accelerate deductions in the early years of ownership. Maintain detailed records of all capital improvements, as each dollar added to your basis reduces your gain at sale.
Evaluate your DSCR annually to understand whether the property's income supports a refinance that could extract equity tax-free. Refinancing is not a taxable event, making it one of the most tax-efficient ways to access property value.
Before listing:
Model your after-tax proceeds under multiple scenarios: outright sale, 1031 exchange, installment sale, and hold-and-refinance. Compare the net present value of each option over your investment horizon. Engage a CPA specializing in real estate taxation at least six months before your planned sale date.
Capital Gains Tax Planning Timeline for Commercial Property Sales
Years Before Sale: Optimize Basis
Claim depreciation, document improvements, consider cost segregation
6 Months Before: Engage Tax Team
Model scenarios with CPA: outright sale, 1031, installment, hold-and-refi
3 Months Before: Choose Strategy
Select approach and begin 1031 replacement property search if applicable
At Closing: Execute Plan
Time closing date, engage qualified intermediary, structure transaction
Post-Sale: File and Report
Report gain correctly, file Form 8824 for exchanges, track installment payments
At the time of sale:
Consider closing date timing. If you close in December versus January, you may shift your gain recognition into a year with lower overall income. For installment sales, structure payments to align with years when your other taxable income is lowest.
Combine strategies when possible. You can execute a partial 1031 exchange (deferring most of the gain) while receiving some boot (cash) and using installment treatment on the taxable portion.
Building your team:
Successful capital gains tax planning requires a coordinated team: a CPA with commercial real estate expertise, a qualified intermediary for 1031 exchanges, a real estate attorney, and a lender who understands tax-motivated transaction structures. Contact Clearhouse Lending to discuss how our financing options support your tax-efficient exit strategy.
Frequently Asked Questions About Capital Gains Tax on Commercial Real Estate?
What is the capital gains tax rate on commercial real estate in 2025?
The federal long-term capital gains rate is 0%, 15%, or 20% depending on your taxable income. Most commercial investors pay 15% or 20%. Add the 3.8% NIIT for high-income taxpayers, and the effective federal rate reaches 18.8% to 23.8% on appreciation, plus up to 28.8% on depreciation recapture. State taxes add 0% to 13.3% depending on location.
How do I avoid paying capital gains tax on commercial property?
The most common method is a 1031 like-kind exchange, which defers all capital gains by reinvesting proceeds into qualifying replacement property. Other options include Opportunity Zone investments (potential permanent exclusion after 10 years), charitable remainder trusts, and installment sales that spread the tax over multiple years.
Is depreciation recapture taxed differently than capital gains?
Yes. Depreciation recapture under Section 1250 is taxed at a maximum federal rate of 25%, compared to the 20% maximum long-term capital gains rate. Recapture tax applies to the total depreciation claimed (or allowable) during ownership, regardless of whether you actually deducted it.
Can I do a 1031 exchange from commercial to residential property?
Yes, as long as both properties are held for investment or business purposes. You can exchange a commercial office building for a residential rental property because the "like-kind" requirement refers to the nature of the investment, not the property type. However, you cannot exchange into a personal residence.
How long do I need to hold commercial property for long-term capital gains?
You must hold the property for more than 12 months to qualify for long-term capital gains treatment. Properties sold within 12 months are taxed at short-term rates, which match ordinary income rates of up to 37%.
Does refinancing trigger capital gains tax?
No. Refinancing a commercial property is not a taxable event, even if you extract significant equity through a cash-out refinance. This makes refinancing one of the most tax-efficient methods to access property value. Many investors use a permanent loan refinance to pull equity from appreciated properties without triggering any capital gains.
What happens if I inherit commercial property and then sell it?
Inherited property receives a "stepped-up" basis equal to the fair market value at the date of the decedent's death. This eliminates all accumulated depreciation recapture and unrealized appreciation. If you sell shortly after inheriting, your capital gain could be minimal or zero.
Can I deduct capital losses against capital gains from commercial real estate?
Yes. Capital losses from other investments can offset capital gains from commercial property sales. If your total capital losses exceed your capital gains, you can deduct up to $3,000 per year ($1,500 if married filing separately) against ordinary income, with unused losses carrying forward to future years.
Capital Gains Tax Quick Reference: Key Numbers to Know
23.8%
Max Federal Rate (Long-Term + NIIT)
28.8%
Max Recapture Rate (+ NIIT)
45 Days
1031 Exchange ID Period
37.1%
Highest Combined State + Federal