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Tax on Commercial Real Estate Sale

Selling commercial real estate is a big deal. It’s not like buying a new gadget or a car where you pay a sales tax and move on. When it comes to selling commercial properties, there’s something called “capital gains tax” that comes into play.

There’s no need to feel worried, we’re going to break it down into bite size portions. Think of it as a big brother of the regular sales tax you’re used to paying. The difference? Well, it’s all about the numbers. We’re talking significant figures here. But don’t worry, understanding how to handle, lessen, or even delay these capital gains taxes is key. Here we will guide you through it all.

Quick Read

  • Capital gains are the profits you make on selling a property.
  • Short-term and long term capital gains tax rates are based on whether you have owned the property for less than a year or not.
  • Depreciation recapture tax is usually the same as the income tax rate and needs to be considered before selling your property..
  • Like-kind exchanges and opportunity zone investments are good strategies to minimize or defer tax liabilities.
  • Consider partnering with Point Acquisitions for expert guidance and tailored solutions in real estate transactions.

What are Capital Gains

Capital gains might sound fancy, but it’s simply the profits you make when you sell something for more than what you paid for it. In the context of commercial real estate, it’s the difference between what you bought the property for and what you sell it for. So, if you bought a commercial building for $500,000 and later sold it for $700,000, you’ve made a capital gain of $200,000.

Types of Capital Gains Tax

When it comes to capital gains tax, there are two main types: short-term and long-term.

Short-term Capital Gains Tax: This applies to assets that are held for one year or less before being sold. These gains are taxed at your regular income tax rate, which is higher than the rate for long-term gains.

Long-term Capital Gains Tax: If you hold onto your property for more than one year before selling it, you may qualify for long-term capital gains tax treatment. The tax rates for long-term gains are typically lower than those for short-term gains, providing potential tax savings.

Short-Term Capital Gains Tax

Short-term capital gains tax applies to profits made from the sale of assets that have been owned for one year or less.

Tax Rate: Short-term capital gains are taxed at your ordinary income tax rate. This means that the rate you pay on short-term gains is the same as the rate you pay on your regular income from sources like salaries and wages.

Higher Tax Rates: Since short-term capital gains are taxed at ordinary income tax rates, they often result in higher tax liabilities compared to long-term capital gains. Depending on your income level, this can impact the amount of taxes owed on your commercial real estate sale.

When planning to sell commercial property, it’s important to take into account the short-term capital gains tax implications. Strategies such as timing the sale to qualify for long-term capital gains treatment helps minimize tax liabilities and maximizes your after-tax proceeds.

Long-Term Capital Gains Tax

Long-term capital gains tax applies to profits made from the sale of assets that have been owned for more than one year.

Tax Rate: Unlike short-term capital gains, long-term capital gains are taxed at preferential rates, which are typically lower than ordinary income tax rates. The exact rate depends on your filing status and taxable income.

Lower Tax Rates: The lower tax rates on long-term capital gains are designed to incentivize long-term investments. Depending on your income level, this can result in substantial tax savings compared to short-term capital gains.

When selling commercial real estate, aiming for long-term capital gains treatment is advantageous from a tax perspective. By holding onto the property for more than one year before selling, you may qualify for these lower tax rates, thereby reducing your overall tax burden.

Depreciation Recapture Tax

In addition to capital gains tax, commercial property owners should know about depreciation recapture tax. When you own commercial real estate, you can deduct the cost of the property over time through depreciation. Essentially, this means spreading out the expense of the property over its useful life for tax purposes.

However, when you sell the property, the IRS “recaptures” some of the depreciation deductions you previously claimed. This recaptured depreciation is taxed as ordinary income, not as capital gains.

Depreciation recapture tax is typically taxed at your ordinary income tax rate, which can result in a higher tax liability compared to capital gains tax rates.

Here is an example of how this looks in a real life situation: 

Purchase and Depreciation:

  • Someone buys a commercial building for $1,000,000. The building is worth $800,000 (excluding the land).
  • They can reduce their taxable income each year by claiming depreciation because buildings lose value over time (39 years). Let’s say they claim $20,513 in depreciation each year (800,000/39).

Selling the Building:

  • After 10 years, they’ve claimed a total of $205,130 in depreciation.
  • The value of the building for tax purposes is now reduced to $594,870 ($800,000 – $205,130).
  • They sell the building for $1,200,000 after 10 years. The part of the sale price for the building is $1,000,000.

Calculating Tax:

  • The $205,130 in depreciation they claimed earlier needs to be “recaptured.” This tax is at a special rate (up to 25%).
  • They also pay a regular capital gains tax on any extra profit, which in this case is the difference between the selling price of the building ($1,000,000) and its depreciated value ($594,870).

Depreciation recapture tax can affect your overall tax burden when selling commercial real estate. It’s important to factor in this additional tax liability when planning your property sale and explore strategies to minimize it.

How to Calculate Your Capital Gains Tax

Calculating your capital gains tax is far easier when you have a clear idea of all the separate parts that need to be identified and accounted for.

Determine Your Capital Gain:

Start by calculating your capital gain from the sale of your commercial property. This involves subtracting the property’s adjusted basis (usually the purchase price plus any improvements minus depreciation deductions) from the sale price.

Identify Your Holding Period:

Determine whether your capital gain qualifies as short-term or long-term based on how long you’ve owned the property before selling it.

Determine Your Tax Rate:

Depending on whether your gain is short-term or long-term, your capital gains tax rate will vary. Short-term gains are taxed at your ordinary income tax rate, while long-term gains are taxed at preferential rates, which are generally lower.

Consider Depreciation Recapture:

If you’ve claimed depreciation deductions on your commercial property, you’ll need to factor in depreciation recapture tax, which is taxed at your ordinary income tax rate.

Consult a Tax Professional:

Calculating capital gains tax involves various factors and nuances. Consulting with a tax professional guarantees accuracy and helps you explore ways to defer or minimize tax liability. Strategies such as like-kind exchanges or investing in opportunity zones are 2 effective ways to keep more money in your pockets.

Strategies for Reducing or Avoiding Capital Gains Tax

When it comes to managing the tax implications of selling commercial real estate, there are several strategies available to help minimize or defer capital gains tax burdens.

Deferring Capital Gains Taxes with a 1031 Exchange

A 1031 exchange, also known as a like-kind exchange, provides commercial real estate investors with an effective way for deferring capital gains taxes. By reinvesting the proceeds from the sale of one property into another similar property, investors defer paying capital gains tax until a later date. This strategy allows for the preservation and potential growth of investment capital.

Taking Advantage of Tax Credits & Deductions

Reviewing tax credits and deductions specific to commercial real estate helps offset capital gains tax liabilities. Examples include:

  • Deductions for depreciation
  • Mortgage interest
  • Property taxes
  • Expenses related to property maintenance and management.

Additionally, tax credits, such as those available for energy-efficient upgrades or investments in low-income housing, further reduce tax burdens.

Tax-Loss Harvesting

Tax-loss harvesting involves strategically selling investments that have incurred losses to offset capital gains from the sale of commercial real estate. By realizing losses in other areas of your investment portfolio, you can reduce your overall tax liability on capital gains. This strategy requires careful consideration of timing and individual investment circumstances.

Capital Gain Taxes and Opportunity Zones

Investing in designated opportunity zones presents an opportunity to defer, reduce, or even eliminate capital gains taxes. These economically distressed areas offer tax incentives to investors who deploy capital gains into qualified opportunity zone investments. By taking advantage of these incentives, investors can optimize the tax efficiency of their real estate transactions while contributing to community development.

How Point Acquisitions Can Help

Ready to take control of your commercial real estate transactions and optimize your capital gains tax position? Point Acquisitions has become renowned for its transparent and smooth buyers process. 

Using the latest technology combined with expert market knowledge, we guarantee you a fair and competitive offer for your commercial real estate in double quick time. Take advantage of those time frames for a 1031 exchange and invest your capital gains into another project!

With companies like Point Acquisitions, savvy investors are wising up and realizing that selling commercial real estate has never been so easy or profitable. Don’t let capital gains tax deter you from commercial real estate investments. Contact Point Acquisitions today to get started!

Summary

Managing the tax implications of selling commercial real estate is far from straightforward, but with the right knowledge and strategies, it’s entirely manageable. In this article we reviewed the concept of capital gains tax and its impact on commercial property transactions. We discussed the distinction between short-term and long-term capital gains tax rates, as well as the additional consideration of depreciation recapture tax.

We highlighted various strategies for reducing or deferring capital gains tax liabilities, including like-kind exchanges, opportunity zone investments, and tax-loss harvesting. These strategies offer valuable opportunities for commercial real estate investors to optimize their tax positions and maximize their after-tax proceeds.

For whatever reason you’re looking to sell your commercial real estate, knowing what to expect from tax liability and knowing how to defer or reduce it gives you the impetus. Recapture your passion for investment by selling to those who know how to help you line your pockets even more. Contact Point Acquisitions today!

Frequently Asked Questions

What is the best way to defer capital gains taxes when selling commercial real estate?

One strategy to defer capital gains taxes is through a like-kind exchange, also known as a 1031 exchange. This allows you to reinvest the proceeds from the sale into a similar property, thereby deferring capital gains taxes until a later date.

How can I estimate my capital gains tax bill on an investment property sale?

To estimate your capital gains tax liability, subtract the property’s adjusted basis (usually the purchase price plus improvements) from the sale price to determine your capital gain. Then, apply the appropriate capital gains tax rate to calculate your potential tax bill.

Do I have to pay taxes immediately when selling investment property?

Generally, yes. Capital gains taxes are typically due in the year of the property sale. However, there are strategies available, such as like-kind exchanges, that allow you to defer paying taxes on capital gains until a later date.

About The Author

Jesse Shemesh

With a wealth of experience in nurturing diverse commercial real estate investment portfolios across multiple markets, I actively engage in the development and execution of deals spanning all asset classes. My expertise lies in collaborating with strategic partners, including corporate real estate professionals, fund managers, developers, and investors, to source, identify, and entitle opportunities. At Point Acquisitions, we take pride in our unique, proprietary platform that specializes in property acquisitions, generating a steady stream of organic deal flow that sets us apart from the competition. As a seasoned professional in the real estate industry, I am dedicated to creating lasting partnerships and delivering exceptional results for all stakeholders.

Disclaimer

Please note that Point Acquisitions is not a tax expert or tax advisor. The information on our blogs and pages is for general informational purposes only and should not be relied upon as legal, tax, or accounting advice. Any information provided does not constitute professional advice or create an attorney-client or any other professional relationship. We recommend that you consult with your tax advisor or seek professional advice before making any decisions based on the information provided on our blogs and pages. Point Acquisitions is not responsible for any actions taken based on the information provided on our blogs and pages.

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