Tax Planning for Commercial Property Sales

Why Does Tax Planning Matter Before Selling Commercial Property?

Selling a commercial property without a tax strategy is one of the most expensive mistakes investors make. Federal capital gains taxes alone can claim 15% to 20% of your profit, and when you add depreciation recapture at 25%, state income taxes, and the 3.8% Net Investment Income Tax (NIIT), your total tax burden can easily exceed 40% of the sale proceeds.

Strategic tax planning before a commercial property sale is the process of structuring timing, entity ownership, and reinvestment vehicles to legally minimize your tax liability. The key is starting early. Most powerful tax reduction strategies require months of advance preparation, making last-minute planning far less effective.

This guide covers every major strategy available to commercial property sellers in 2026, from installment sales and 1031 exchanges to charitable remainder trusts and Opportunity Zone reinvestment. Whether you own a single retail building or a portfolio of multifamily assets, these approaches can help you retain significantly more of your sale proceeds. If you are considering a sale or refinance, use our commercial mortgage calculator to model your current position before diving into tax strategy.

What Are the Tax Obligations When You Sell Commercial Real Estate?

Before you can plan around taxes, you need to understand exactly what you owe. Commercial property sales trigger multiple layers of taxation that stack on top of each other.

Capital Gains Tax applies to the difference between your adjusted basis and the sale price. For properties held longer than one year, long-term rates of 15% or 20% apply depending on taxable income. Short-term gains on properties held less than one year are taxed as ordinary income at rates up to 37%.

Depreciation Recapture often catches sellers off guard. The IRS requires you to "recapture" all depreciation deductions taken during ownership and tax that amount at 25% under Section 1250. For a property depreciated over 20 years, this recapture amount can be substantial and often exceeds the capital gain itself.

Net Investment Income Tax (NIIT) adds a 3.8% surtax on investment income for individuals earning above $200,000 (single) or $250,000 (married filing jointly). This applies to capital gains and cannot be deferred through most standard strategies.

State and Local Taxes vary widely. California taxes capital gains as ordinary income at rates up to 13.3%, while Texas and Florida impose no state income tax. The state where the property is located, not where you reside, typically determines the state tax obligation.

For a deeper breakdown of capital gains calculations, see our capital gains tax guide for commercial real estate.

How Far in Advance Should You Start Tax Planning?

The most effective tax planning begins 12 to 24 months before a sale. Waiting until you have a signed purchase agreement severely limits your options. Here is a practical timeline that maximizes your available strategies.

24 Months Before Sale: Evaluate your entity structure. If your property is held personally, consider whether transferring to an LLC, S-Corp, or partnership could provide tax advantages. Commission cost segregation studies to accelerate remaining depreciation before the sale.

12 to 18 Months Before Sale: Engage a tax attorney and CPA specializing in commercial real estate. Model different sale structures (outright sale, installment sale, 1031 exchange, charitable trust) to compare after-tax proceeds. If you plan to use a 1031 exchange, start identifying replacement properties early.

6 to 12 Months Before Sale: Finalize your chosen strategy and ensure all legal structures are in place. If pursuing a 1031 exchange, select a qualified intermediary. Review your overall income situation to determine whether accelerating or deferring to a different tax year would be beneficial.

3 to 6 Months Before Sale: List the property and begin marketing. Ensure your purchase agreement includes clauses needed for your tax strategy, such as 1031 exchange cooperation clauses. Confirm all deadlines with your tax team.

At Closing: Execute the planned strategy precisely. Missed deadlines or procedural errors can disqualify tax benefits entirely. Your qualified intermediary, tax attorney, and CPA should all be coordinated.

If you need bridge financing to acquire replacement property before your current sale closes, Clearhouse Lending can help structure the timing.

What Is an Installment Sale and How Does It Reduce Taxes?

An installment sale spreads your capital gains tax liability over multiple years by receiving sale proceeds in scheduled payments rather than a lump sum. Under IRS Section 453, you only recognize gain proportionally as you receive each payment.

How it works: The buyer pays you over time with interest. You report gain on each payment based on your "gross profit ratio," which is total gain divided by total contract price.

Example: You sell for $2,000,000 with an adjusted basis of $800,000, creating a $1,200,000 gain. Your gross profit ratio is 60%. If the buyer pays $400,000 per year over five years, you recognize $240,000 in gain each year instead of the full $1,200,000 in year one.

Tax Advantages:

• Keeps income in lower tax brackets each year
• May help avoid the 20% capital gains rate threshold
• Reduces or eliminates the 3.8% NIIT in some years
• Provides a steady income stream with interest

Risks to Consider:

• Buyer default risk on remaining payments
• Interest income taxed as ordinary income
• Cannot combine with a 1031 exchange on the same property
• Depreciation recapture must still be recognized in year one

Installment sales work best for sellers who do not need immediate access to full proceeds and want to manage their tax bracket year over year. For sellers who need immediate liquidity, a refinance before selling can provide cash while preserving installment sale benefits.

How Can a 1031 Exchange Defer Your Entire Tax Bill?

A 1031 exchange allows you to defer all federal capital gains taxes and depreciation recapture by reinvesting sale proceeds into "like-kind" replacement property. This is the single most powerful tax deferral tool for commercial real estate investors.

Like-Kind Requirement: Any real property held for investment or business use qualifies. You can exchange a retail strip mall for an apartment complex, an office building for raw land, or a warehouse for a medical office. The replacement property simply must be real estate held for productive use.

Critical Deadlines:

• 45-Day Identification Period: Identify potential replacement properties in writing within 45 days of closing.
• 180-Day Exchange Period: Close on replacement property within 180 days of the original sale.

Identification Rules: You may identify up to three properties of any value (Three-Property Rule), or any number totaling no more than 200% of the relinquished property's value (200% Rule).

Common Mistakes That Disqualify Exchanges:

• Taking constructive receipt of funds (proceeds must go to a qualified intermediary)
• Missing the 45-day or 180-day deadline by even one day
• Failing to reinvest full proceeds, resulting in taxable "boot"
• Using a related party as the qualified intermediary

For a comprehensive walkthrough, read our 1031 exchange guide for commercial real estate. Our permanent loan programs and bridge loans are designed to work within tight 1031 exchange timelines. Contact us to discuss your exchange financing needs.

What Advanced Strategies Exist Beyond 1031 Exchanges?

Several advanced strategies can provide even greater tax benefits depending on your financial situation and long-term goals.

Charitable Remainder Trusts (CRTs)

A CRT allows you to transfer appreciated property into an irrevocable trust before selling. The trust sells the property tax-free, invests the full proceeds, and pays you an income stream for life or up to 20 years. Remaining assets go to a designated charity.

Tax Benefits: No capital gains tax at sale, immediate charitable deduction, diversification without triggering gains, and steady retirement income.

Limitations: You permanently give up the principal, income is taxable as received, and the trust is irrevocable. CRTs work best for investors with significant charitable intent who want lifetime income.

Qualified Opportunity Zone (QOZ) Reinvestment

Investing capital gains into a Qualified Opportunity Zone Fund provides layered tax benefits. You defer the original capital gains tax until December 31, 2026, or when you sell the QOZ investment, whichever comes first. If you hold the QOZ investment for at least 10 years, any appreciation on the QOZ investment is permanently tax-free.

Delaware Statutory Trusts (DSTs)

DSTs let you complete a 1031 exchange into fractional ownership of institutional-quality commercial property. This is useful for investors who want to exit active management while deferring taxes. DSTs qualify as like-kind replacement property under Revenue Ruling 2004-86.

Intentionally Defective Grantor Trusts (IDGTs)

For estate planning purposes, selling property to an IDGT removes the asset from your taxable estate while allowing you to receive an installment note. The sale is not taxable because the IRS treats you as the trust owner for income tax purposes, but the property is excluded from your estate for estate tax purposes.

Should You Sell at the Entity Level or Personal Level?

The entity holding the property determines how the sale is taxed. Restructuring before a sale can produce significant savings. This decision deserves careful analysis with your tax advisor.

Personal Ownership: All gains flow to your personal tax return with no flexibility to allocate gains among partners. You face the full impact of your marginal tax rate plus NIIT.

Single-Member LLC: Tax treatment is identical to personal ownership, but the LLC provides liability protection and can convert to a multi-member LLC before the sale for more flexibility.

Partnership / Multi-Member LLC: Gains flow through to partners based on ownership percentages. Partnerships allow special allocations of gain if the agreement is properly structured. Partners with different tax situations can benefit from strategic allocation.

S-Corporation: Gains pass through to shareholders, but distributions must be proportional to ownership. No special allocations permitted. However, S-Corp ownership can provide self-employment tax savings.

C-Corporation: The least favorable structure. The corporation pays corporate tax on gain, and shareholders pay a second layer on dividends. Avoid selling appreciated property from a C-Corp whenever possible.

Consult a tax attorney about restructuring options at least 12 months before a planned sale. Some restructurings require waiting periods to avoid step-transaction doctrine challenges.

When Is the Best Time to Sell Commercial Property for Tax Purposes?

Timing your sale correctly can reduce your tax bill by thousands without changing anything about the transaction itself. Several timing factors deserve consideration.

Tax Year Income Management: If your income is unusually low in a particular year, closing the sale then keeps capital gains in a lower bracket. If you are already in the highest bracket, deferring the sale to a lower-income year makes sense.

Holding Period: Properties held at least one year qualify for long-term capital gains rates (15% or 20%) instead of ordinary income rates (up to 37%). Waiting past the one-year mark saves more than 17 percentage points on your tax rate.

Legislative Risk: Current long-term capital gains rates are not permanent. If Congress proposes rate increases, accelerating a sale before the effective date could save significant money. Stay current on proposed legislation with your tax advisor.

Section 1231 Netting: Commercial property held over one year qualifies as Section 1231 property. Gains are taxed at capital gains rates, but losses are deductible as ordinary losses. Selling a losing property in the same year as a winner offsets gains with more valuable ordinary losses.

For more disposition approaches, see our commercial development exit strategies guide. Ready to explore financing options? Contact our team for a free consultation.

How Do You Build the Right Tax Advisory Team?

Tax planning for a commercial property sale is not a do-it-yourself project. The stakes are too high and the rules too complex. Building the right team ensures you capture every available benefit.

CPA with CRE Specialization: Your CPA should have specific experience with commercial property transactions, including 1031 exchanges, installment sales, and cost segregation studies. Ask for references from clients who have completed similar transactions.

Real Estate Tax Attorney: An attorney structures the legal aspects, drafts documents, and ensures IRS compliance. Essential for entity restructuring, trust formation, and complex transactions.

Qualified Intermediary (for 1031 Exchanges): Choose a QI with strong financial backing and fidelity bond coverage. The QI cannot be someone who served as your agent within the previous two years.

Commercial Real Estate Broker: A broker experienced in tax-advantaged transactions can include exchange cooperation clauses and flexible closing dates in purchase agreements.

What Are the Most Common Tax Planning Mistakes to Avoid?

Even experienced investors make errors that cost thousands in unnecessary taxes. Avoiding these common pitfalls protects your after-tax returns.

Waiting Too Late to Plan: Once a property is under contract, many strategies are unavailable. Start at least 12 months before a planned sale to preserve all options.

Ignoring Depreciation Recapture: Sellers calculate capital gains tax but forget the 25% recapture tax. On a property depreciated 15 to 20 years, recapture can exceed the capital gain.

Choosing the Wrong 1031 Replacement Property: Rushing within the 45-day window leads to overpaying or buying properties that do not fit your strategy. Pre-identify targets before selling.

Failing to Account for State Taxes: A California seller faces combined rates above 37%. Ignoring state taxes underestimates liability by 5% to 13%.

Mixing Personal and Business Use: Personal-use portions do not qualify for 1031 exchange treatment or business deductions. Document business use thoroughly throughout your ownership period.

Frequently Asked Questions About Tax Planning for Commercial Property Sales?

How much tax will I owe when I sell a commercial property? Your total liability depends on capital gain, depreciation recapture, income level, and state of residence. At the federal level, expect 15% to 20% on long-term gains, 25% on recapture, and potentially 3.8% NIIT. Combined federal and state rates can reach 30% to 45% for high-income sellers.

Can I avoid paying taxes entirely on a commercial property sale? You can defer taxes indefinitely through 1031 exchanges. If you continue exchanging throughout your lifetime, heirs receive a stepped-up basis at death, effectively eliminating deferred gain. Opportunity Zone investments held 10+ years provide permanent tax-free treatment on appreciation.

What is the difference between tax deferral and tax elimination? Deferral postpones liability to a future date (1031 exchanges, installment sales). Elimination permanently removes it (stepped-up basis at death, Opportunity Zone appreciation after 10 years). Most strategies are deferrals that can become eliminations through proper estate planning.

Do I need a 1031 exchange if my property has losses? No. If your adjusted basis exceeds the sale price, no capital gains tax is owed. Section 1231 losses on commercial property held over one year are deductible as ordinary losses, which are more valuable than capital losses. A 1031 exchange would waste this loss by deferring it.

How does depreciation recapture work on commercial property? The IRS taxes all depreciation claimed during ownership at 25% under Section 1250. For a $1,000,000 property with $200,000 in land value, you depreciate $800,000 over 39 years. After 20 years, approximately $410,000 in depreciation is recaptured at 25%, costing roughly $102,500 in recapture tax alone.

Can I do a partial 1031 exchange? Yes. The unreinvested portion (called "boot") is taxable. If you sell for $1,000,000 and reinvest $800,000, the $200,000 in boot is taxable. Many sellers intentionally take some boot for cash while deferring the majority of their gain.

What happens if I miss the 1031 exchange 45-day identification deadline? The exchange fails entirely. There are no extensions or exceptions for missing the 45-day identification window. All gain becomes taxable in the year of the original sale. Pre-identifying replacement properties before closing is critical.

Should I sell before potential tax law changes? If credible legislation would increase capital gains rates, accelerating a planned sale could save significant money. However, selling prematurely to avoid speculative changes can lead to poor investment decisions. Discuss specific proposals with your tax attorney before making timing decisions.

Sources and References?

1. Internal Revenue Service, "Like-Kind Exchanges Under IRC Section 1031," IRS.gov Publication 544 (2025).
2. Internal Revenue Service, "Installment Sales," IRS.gov Publication 537 (2025).
3. National Association of Realtors, "2025 Commercial Real Estate Outlook: Tax Policy Impact," NAR Research (2025).
4. Tax Foundation, "Federal Capital Gains Tax Rates, 1954 to 2026," Tax Foundation Fiscal Fact No. 842 (2025).
5. Joint Committee on Taxation, "Overview of Federal Tax Provisions Relating to Real Estate," JCX-12-25 (2025).

This guide is for informational purposes only and does not constitute tax or legal advice. Consult a qualified tax professional before making decisions about your specific situation.

Considering selling or refinancing your commercial property? Contact Clearhouse Lending to explore your financing options and connect with commercial real estate tax professionals.