Today’s rates for a wide range of commercial property and loan types.
Check Today's Rates →
Capital Gains Taxes in Commercial Real Estate
For commercial real estate investors, understanding the impact of capital gains taxes — and how to minimize that impact — is essential to maximizing returns.
- Capital Gains Tax Considerations for Commercial Real Estate Investors
- Short- vs. Long-Term Investment Strategies
- Breaking Down Capital Gains Taxes
- Long-Term Capital Gains Taxes in 2023
- Short-Term Capital Gains Taxes in 2023
- Single Filer Short-Term Capital Gains Taxes
- Married (Filing Separately) Filer Short-Term Capital Gains Taxes
- Married (Filing Jointly) Filer Short-Term Capital Gains Taxes
- Head of Household Filer Short-Term Capital Gains Taxes
- Recapture Tax
- State Capital Gains and Income Taxes
- 1031 Exchanges and Capital Gains Taxes
- Opportunity Zones and Capital Gains Taxes
- When It Comes to Capital Gains Taxes, Strategy is Key
- Related Questions
- Get Financing
Capital Gains Tax Considerations for Commercial Real Estate Investors
When an individual profits from selling an asset, such as stock in a company, commercial real estate, or other investments, a capital gain has occurred.
Instead of paying ordinary income tax, an individual generally must pay a special tax rate on these gains. This is known as a capital gains tax.
Capital gains taxes vary depending on how long you hold and how you divest from a commercial property.
For commercial real estate investors, understanding the impact of capital gains taxes — and how to minimize their impact — is essential if you want to maximize the profitability of your investment.
In this article, we’ll discuss:
Short-Term vs. Long-Term Investment Strategies: Commercial real estate investors with different goals often have different holding/exit strategies for commercial real estate.
Short-Term vs. Long-Term Capital Gains: Investors are taxed at different rates depending on how long they hold onto an asset.
1031 Exchanges: 1031 exchanges allow investors to defer capital gains taxes by using proceeds from an investment property to purchase a “like kind” property.
Depreciation Recapture Taxes: When an investor sells a property they have used to take depreciation deductions, they will have to pay taxes on those deductions.
The Opportunity Zones Program: The Opportunity Zones program allows investors to defer paying capital gains taxes until Dec. 31, 2026, provided they invest in a Qualified Opportunity Fund. Additional benefits are provided by those who invested before Dec. 31, 2019.
What are the capital gains tax implications of investing in commercial real estate?
Investing in commercial real estate can have a variety of capital gains tax implications. At the federal level, capital gains taxes are imposed on the profits from the sale of a capital asset, such as a commercial real estate property. The amount of capital gains tax owed depends on the investor's tax bracket and the length of time the asset was held. In addition to federal tax considerations, investors may also have to pay state capital gains taxes or state income taxes, if they reside in a state with an income tax. Different states will calculate an investor’s capital gains tax burden in different ways, so it’s essential to understand your state’s tax regulations if you want to minimize your capital gains tax bill. A map of the U.S. with tax rates for individual states can be found here.
How do capital gains taxes affect the profitability of commercial real estate investments?
Capital gains taxes can have a significant impact on the profitability of commercial real estate investments. Short-term investments may be subject to higher taxes, while long-term investments may be eligible for more favorable tax treatment. Investors should create an exit strategy and begin the tax planning process before they make an commercial real estate investment in order to maximize their chances of success. Additionally, investors can get creative with their income, engage in a 1031 exchange, or even defer taxes via investing in the Opportunity Zones program.
What are the tax benefits of investing in commercial real estate?
Investing in commercial real estate can offer a variety of tax benefits, such as accelerated depreciation, mortgage interest deductions, and reduced tax burdens for beneficiaries.
Accelerated depreciation allows investors to deduct the cost of the property over a shorter period of time than the property's useful life. This can lead to a significant reduction in taxes.
Mortgage interest deductions allow investors to deduct the interest paid on their mortgage from their taxable income. This can also lead to a significant reduction in taxes.
Finally, reduced tax burdens for beneficiaries can save an investor’s heirs hundreds of thousands or even millions of dollars. If an investor buys a commercial property for $3 million, and its value increases to $4.5 million before the investor passes away, the investor’s beneficiaries will only need to pay taxes on the $1.5 million that the property has appreciated, not the entire $4.5 million sale price.
Are there any tax incentives for investing in commercial real estate?
Yes, there are several tax incentives for investing in commercial real estate. These include accelerated depreciation, mortgage interest deductions, and tax advantages for an investor’s heirs. The Low-Income Housing Tax Credit (LIHTC) program allows investors in qualified low-income properties to take a dollar-for-dollar deduction against their federal income taxes. The Historic Tax Credit (HTC) program offers a tax credit based on the percentage of eligible expenses used to rehabilitate a historic building for commercial use. The New Markets Tax Credit Program provides a tax credit for commercial development in low-income areas.
It’s important to consult with an experienced tax professional in order to better understand how each of these tax benefits may be able to work for you. Real estate taxes can be incredibly complex, and the more effort you put into preparation and documentation, the more money you’ll save in the long run — not to mention avoiding the possibility of an unpleasant visit from the IRS.
What are the long-term capital gains tax implications of investing in commercial real estate?
When investing in commercial real estate for the long-term, investors are generally taxed at a lower rate than short-term investments. The long-term capital gains tax rate is 0%, 15%, or 20%, depending on the investor's income level. Additionally, investors can defer capital gains taxes by using proceeds from an investment property to purchase a “like kind” property through a 1031 exchange. Finally, investors can take advantage of the Opportunity Zones program, which allows them to defer paying capital gains taxes until December 31, 2026, provided that they invest in an Qualified Opportunity Fund. Additional benefits are provided by those who invest before December 31, 2019.
Short- vs. Long-Term Investment Strategies
When investing in commercial real estate, understanding your exit strategy is key. Some investors like to purchase underperforming properties with potential, increase occupancies and rents, and (if needed) do some value-add repairs, and sell the property within a few years.
Others prefer to buy an investment and hold it for the long run, allowing them to collect a steady income from the investment for several decades. Whichever strategy an investor chooses will have a significant impact on their capital gains tax burden — and how they should address that burden to maximize profitability.
Breaking Down Capital Gains Taxes
Taxes on capital gains are different for long-term capital gains and short-term capital gains. Short term capital gains are generally defined as gains on assets held for less than one year, while long term capital gains are generally defined as gains on assets held for more than one year. Both types of capital gains taxes are based on a taxpayer’s income and filing status.
Long-Term Capital Gains Taxes in 2023
Long-term federal capital gains taxes are outlined in the table below, based on data from the Internal Revenue Service.
Filing Status | No Tax | 15% Tax | 20% Tax |
|---|---|---|---|
Single | $44,625 or less | $44,626 to $492,300 | More than $492,300 |
Married (joint filing) | $89,250 or less | $89,251 to $553,850 | More than $553,850 |
Married (filing separately) | $44,625 or less | $44,626 to $276,900 | More than $276,900 |
Head of Household | $59,750 or less | $59,741 to $523,050 | More than $523,050 |
Remember that, just like with income taxes, the tax rate is applicable only to the dollar amounts within their respective range.
For example, capital gains of $50,000 for a single filer would incur only a 15% tax on any amount above $44,625. In this example, that tax would equal $806.25 ($5,375 x 15%).
Short-Term Capital Gains Taxes in 2023
Short term capital gains taxes are taxed at a taxpayer's ordinary tax bracket.
Single Filer Short-Term Capital Gains Taxes
Federal income tax rates for 2023 for single filers are listed below.
Income | Tax Rate |
|---|---|
Up to $11,000 | 10% |
Between $11,000 and $44,725 | 12% |
Between $44,725 and $95,375 | 22% |
Between $95,375 and $182,100 | 24% |
Between $182,100 and $231,250 | 32% |
Between $231,250 and $578,125 | 35% |
More than $578,125 | 37% |
Married (Filing Separately) Filer Short-Term Capital Gains Taxes
For individuals who are married but filing separately, the following rates are used.
Income | Tax Rate |
|---|---|
Up to $11,000 | 10% |
Between $11,000 and $44,725 | 12% |
Between $44,725 and $95,375 | 22% |
Between $95,375 and $182,100 | 24% |
Between $182,100 and $231,250 | 32% |
Between $231,250 and $346,875 | 35% |
More than $346,875 | 37% |
Married (Filing Jointly) Filer Short-Term Capital Gains Taxes
Married filers who file jointly must pay the following rates for their income in 2023.
Income | Tax Rate |
|---|---|
Up to $22,000 | 10% |
Between $22,000 and $89,450 | 12% |
Between $89,450 and $190,750 | 22% |
Between $190,750 and $364,200 | 24% |
Between $364,200 and $462,500 | 32% |
Between $462,500 and $693,750 | 35% |
More than $693,750 | 37% |
Head of Household Filer Short-Term Capital Gains Taxes
Finally, the income tax brackets below apply to short-term capital gains and any other income for head-of-household filers in 2023.
Income | Tax Rate |
|---|---|
Up to $15,700 | 10% |
Between $15,700 and $59,850 | 12% |
Between $59,850 and $95,350 | 22% |
Between $95,350 and $182,100 | 24% |
Between $182,100 and $231,250 | 32% |
Between $231,250 and $578,100 | 35% |
More than $578,100 | 37% |
Recapture Tax
As a way to reduce their taxable income, commercial and multifamily investors are permitted to depreciate a property. This means that, as a property ages, they can take part of that aging as a loss and utilize it as an income tax deduction. However, they will still have to pay taxes on this amount later.
For instance, if an investor purchase a $500,000 property, and, while holding it, was allowed to take $150,000 in accumulated depreciation, they would need pay taxes on that $150,000 when they sell the property — but only if they sell the property for more than the depreciated value. For instance, if the investor sold the property for less than $350,000, the investor would not need to pay taxes on the $150,000 of accumulated depreciation they took. Accumulated depreciation, which is also called a Section 1250 gain, is taxed at up to 25%.
In addition, it may be important to note that commercial real estate investors, particularly multifamily investors, may be able to “accelerate depreciation” by ordering a cost segregation study, which will identify areas of a property that can be depreciated more quickly. This can greatly reduce an investor’s tax burden in the initial years of an investment, but all accumulated depreciation will still be subject to the depreciation recapture tax.
State Capital Gains and Income Taxes
In addition to federal tax considerations, investors also will generally have to pay state capital gains taxes or state income taxes, if they reside in a state with an income tax.
Different states will calculate an investor’s capital gains tax burden in different ways, so it’s essential to understand your state’s tax regulations if you want to minimize your capital gains tax bill. A map of the U.S. with tax rates for individual states can be found here.
1031 Exchanges and Capital Gains Taxes
One of the best ways to reduce the impact of capital gains taxes on a commercial real estate portfolio is to utilize a 1031 exchange. 1031 exchanges permit investors to defer the payment of capital gains taxes on commercial real estate, provided that they purchase a similar, “like-kind” commercial property of equal to or greater value. Homes used as a primary residence are not eligible.
While the investor will eventually have to pay taxes if they sell the second property (unless they engage in another 1031 exchange) avoiding paying taxes in the present is highly advantageous — as you undoubtedly know, a dollar today is worth more than a dollar tomorrow. In fact, some investors elect exchange properties indefinitely, acquiring increasingly profitable pieces of commercial real estate while avoiding capital gains taxes.
Opportunity Zones and Capital Gains Taxes
The Opportunity Zones program, created as a result of the Tax Cuts and Jobs Act of 2017, is another way that commercial real estate investors can defer paying capital gains taxes on the sale of investment properties. The program permits investors to defer their capital gains taxes until Dec. 31, 2026, provided they reinvest their money into an Opportunity Fund. Opportunity Funds are specialized investment vehicles which must place at least 90% of their assets in qualified businesses or investment properties located in one or more of the 8,700 Qualified Opportunity Zones throughout the United States. Opportunity Zones consist of some of the lowest-income census tracts in country, and, as such, have been deemed as areas ripe for economic redevelopment.
In addition to deferring capital gains taxes for up to eight years, investors who hold their investments for a minimum of five years prior to Dec. 31, 2026, can take a 10% reduction in their capital gains tax basis. And, investors who hold their investments held for a minimum of seven years prior to Dec. 31, 2026, can take an additional 5% reduction in their capital gains tax basis (for a total 15% reduction). To take full advantage of the program, however, investors must have placed their money in an Opportunity Fund before the end of 2019.
In contrast to 1031 exchanges, investors aren’t limited to reinvesting funds from the sale of commercial property. Instead, they are permitted to reinvest funds from the sale of stock shares, the sale of a business, or the sale of other types of investments into an Opportunity Fund in order to defer their capital gains taxes.
When It Comes to Capital Gains Taxes, Strategy is Key
While no one likes paying taxes, with sufficient knowledge, commercial real estate investors can turn a burden into an opportunity — whether by getting creative with their income (for instance, a business owner who wants to take a smaller salary for tax benefits), engaging in a 1031 exchange, or even deferring taxes via investing in the Opportunity Zones program.
However, to maximize their chances of success, investors should think through a concrete exit strategy and begin the tax planning process before they make a commercial real estate investment — not after.