For many property owners, the amount of tax owed after a sale is a major concern. Knowing the value helps you plan for the potential tax implications and make informed decisions regarding reinvestment or other ventures. How much tax do you pay when you sell a commercial property? There are a few factors to keep in mind to get an accurate estimate before you commit to a sale. Realized 1031 has shared an informative guide to help you understand these considerations. Keep reading to learn more.
On the Federal Level
When we discuss tax liability for a property sale, most investors or owners would probably be referring to taxes at the federal level. Tax payments are unavoidable, especially if you sell at a profit. The profit is considered income — more specifically, capital gains. This value is the increase in the asset’s original value over its original purchase price. You realize these capital gains upon the sale of the asset.
The IRS has a different tax classification for long-term capital gains, which is assigned to assets held for more than a year. These are not taxed at the same rate as ordinary income. As of 2024, these are the IRS rates for capital gains taxes for single taxpayers' income.
- 0%: Up to $47,025
- 15%: $47,026 to $518,900
- 20%: Over $518,900
Based on the figures above, taxpayers with incomes within the provided ranges will be liable to pay the respective rates. Let’s say that John was able to sell a commercial office building he purchased with a value of $500,000 for $800,000. John earned $300,000 in federal capital gains, and his resulting annual taxable income is $520,000. If this is John’s only income, the calculation would be:
$300,000 (Capital Gains) * 0.20 (Capital Gains Tax Rate) = $60,000 (Federal Capital Gains Tax)
The numbers above provide a simplified calculation of how much John may owe in capital gains taxes after selling the office building. This calculation does not account for potential deductions (e.g., selling costs), depreciation recapture (which may be taxed at up to 25%), or the 3.8% Net Investment Income Tax (NIIT). Other factors can still apply, affecting his overall tax liability. This includes capital gains levied by the state where the property is located.
State-Level Capital Gains Tax Considerations
In addition to federal capital gains tax obligations, many states impose state-level income tax on capital gains. However, state treatment varies widely:
Some states (e.g., Florida, Texas, and Washington) do not impose a personal income tax and, therefore, do not tax capital gains.
Other states, like California, tax capital gains as ordinary income, with relatively high marginal rates.
Example: California Capital Gains Tax
California taxes all income—including capital gains—at the same rates as ordinary income. As of 2024, the top marginal rate is 13.3%, with an additional 1% surtax for taxable income above $1 million, bringing the maximum effective rate to 14.3%.
Let’s revisit our earlier hypothetical scenario, assuming the property is located in California:
Capital Gain: $300,000
Estimated California Tax Rate: 14.4% (for high-income earners)
State Tax Estimate: $300,000 × 14.4% = $43,200
Strategies That Can Help With Capital Gains Taxes
There are a few tax-advantaged investment strategies you can try to help manage capital gains taxes. Each option has specific rules, holding requirements, and risks that should be carefully evaluated by tax and legal professionals.
- 1031 Exchange: The like-kind swap or 1031 Exchange allows you to defer tax liability by exchanging assets of similar use. Commercial properties are qualified because these are income-generating real estate — a core requirement in 1031 Exchanges. You only need to pay capital gains once a triggering event occurs, such as the sale of the replacement property. The exchange must follow IRS requirements for timing (e.g., 45-day identification and 180-day closing rules) and value reinvestment to achieve full deferral.
- Delaware Statutory Trust (DST): Entering a DST can serve as a qualifying replacement property in a 1031 Exchange, allowing you to own fractional beneficial interests of the trust that manages an income-generating property. DSTs are generally illiquid and passive, and are typically offered to accredited investors under Regulation D.
- Opportunity Zone Funds (QOF): Reinvesting capital gains into qualified opportunity funds (QOF) may defer taxes and potentially reduce them. Hold the investment for 10 years, and future gains from the fund can be tax-free. It’s a strategic way to support community development while minimizing your tax burden. However, the original deferred gain becomes taxable on December 31, 2026, regardless of the QOF’s performance.
Wrapping Up: Tax Payments After a Commercial Property Sale
How much tax do you need to pay when selling commercial real estate? On the federal level, capital gains tax rates can be as high as 20%, with an additional 3.8% Net Investment Income Tax (NIIT) for certain high-income earners. Additional taxes—such as depreciation recapture—may also apply. At the state level, some jurisdictions tax capital gains as ordinary income, with California imposing rates up to 13.3%, depending on the investor’s income level. Understanding the potential tax implications of a sale can help investors plan ahead. Consulting with a tax advisor can help you navigate these rules, understand available deductions, and explore strategies like 1031 Exchanges or Opportunity Funds to reduce your taxable gains.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.investopedia.com/terms/c/capitalgain.asp
