In an ideal commercial real estate investment scenario, an investor acquires a property, holds it for a period of time, and ultimately sells it for more than the purchase price. While the resulting profit is a positive outcome, it also triggers tax considerations that can materially impact net returns.
In this article, we walk through how capital gains on commercial real estate are taxed, why those taxes matter, and how they are calculated. We also discuss when it may make sense to defer capital gains taxes — and when paying them outright may be the more practical choice. The goal is to equip investors with a clearer framework they can incorporate into their pre-investment due diligence and long-term exit planning.
What is a Capital Gain on Commercial Property?
To understand capital gains taxes, it is first necessary to define what a capital gain actually is.
In simple terms, a capital gain (sometimes called a gain on sale) is the difference between a property’s sale price and its adjusted cost basis. The cost basis generally starts with the purchase price and is adjusted over time for capital improvements and depreciation deductions.
Example
Assume an investor acquires a commercial property for $5 million and holds it for five years. During that period, IRS rules allow the investor to take $100,000 per year in depreciation deductions, reducing the cost basis by $500,000. At the time of sale, the adjusted basis is $4.5 million. If the property sells for $6 million, the taxable gain is $1.5 million.
How that $1.5 million gain is taxed depends largely on how long the property was held and how depreciation was treated during ownership.
Short-Term vs. Long-Term Capital Gains Taxes
Commercial real estate, like stocks and bonds, is considered a capital asset under IRS rules. When it is sold at a profit, the IRS applies capital gains taxes based on the holding period.
Short-Term Capital Gains
If a property is held for less than one year, the gain is classified as short term and taxed as ordinary income. This means the gain is subject to the investor’s marginal income tax rate, which can be as high as 37% at the federal level.
Long-Term Capital Gains
If a property is held for more than one year, the gain qualifies as long-term and is taxed at preferential capital gains rates. These rates depend on income and filing status, but the maximum federal long-term capital gains rate is currently 20%, which is significantly lower than the top ordinary income tax rate.
For many investors, this differential alone creates a strong incentive to structure investments with a longer-term holding period in mind.
Here’s an illustration of the differences between short- and long-term capital gains taxes:
Ordinary Income Tax Brackets
| Filing Status | 10% Tax Rate | 12% Tax Rate | 22% Tax Rate | 24% Tax Rate | 32% Tax Rate | 35% Tax Rate | 37% Tax Rate |
| Single | $0 – $10,275 | $10,276- $41,775 | $41,776 – $89,075 | $89,076 – $170,050 | $170,051 – $215,950 | $215,951- $539,900 | $539,900+ |
| Head of household | $0 – $14,650 | $14,651-$55,900 | $55,901- $89,050 | $89,051- $170,050 | $170,051- $215,950 | $215,951-$539,900 | $539,900+ |
| Married filing jointly | $0 – $20,550 | $20,551-$83,550 | $83,551- $178,150 | $178,151-$340,100 | $340,101- $431,900 | $431,901- $647,850 | $647,850+ |
| Married filing separately | $0 – $10,275 | $10,276- $41,775 | $41,776- $89,075 | $89,076- $170,050 | $170,051- $215,950 | $215,951- $323,925 | $323,925+ |
Long Term Capital Gains Tax Brackets
| Filing Status | Tax Rate of 0% | Tax Rate of 15% | Tax Rate of 20% |
| Single | $0 – $41,675 | $41,675 – $459,750 | Over $459,750 |
| Head of household | $0 – $55,800 | $55,800 – $488,500 | Over $488,500 |
| Married filing jointly and surviving spouse | $0 – $83,350 | $83,350 – $517,200 | Over $517,200 |
| Married filing separately | $0 – $41,675 | $41,675 – $258,600 | Over $258,600 |
The table above shows that even the highest long term capital gains tax rate is 20%, which is significantly less than the ordinary income tax rate for high earners. This is one of the major benefits of investing in commercial rental property
Factors to Consider When Planning for Capital Gains Taxes
From a planning perspective, the most influential variable is typically holding period. Holding a property for at least one year allows investors to benefit from long-term capital gains rates rather than ordinary income treatment.
However, holding period is only part of the equation. How income, expenses, and depreciation flow through an investment structure also affects both annual tax liability and taxes due at exit.
Most commercial real estate investments are held in pass-through entities, such as limited liability companies (LLCs). Income and expenses flow through the entity and are reported at the investor level, typically via a Schedule K-1. While annual operating income is taxed as it is earned, appreciation is generally taxed only when the property is sold.
Beware of Depreciation Recapture
Depreciation is one of the most valuable tax benefits available to commercial real estate investors. Because buildings and their components wear out over time, the IRS allows owners to deduct a portion of the property’s value each year. These deductions reduce taxable income during the holding period and can meaningfully enhance after-tax cash flow.
However, depreciation also reduces the property’s cost basis. When the property is sold, the IRS requires investors to recapture accumulated depreciation and pay tax on that amount.
Revisiting the earlier example, the investor took $500,000 in depreciation over five years. Upon sale, that $500,000 is subject to depreciation recapture tax, which is generally assessed at higher rates than long-term capital gains. This tax is in addition to the capital gains tax owed on the remaining appreciation.
Because depreciation recapture can materially affect exit proceeds, it should be modeled explicitly when evaluating projected returns.
Deferring Capital Gains Taxes
One of the defining advantages of commercial real estate is that investors may be able to defer, rather than eliminate, capital gains taxes through specific IRS-approved strategies.
1031 Exchanges
A 1031 Exchange, sometimes referred to as a like-kind exchange, allows investors to defer capital gains taxes by reinvesting sale proceeds into another qualifying commercial property. When executed correctly, both capital gains taxes and depreciation recapture can be deferred, allowing capital to compound on a pre-tax basis.
These exchanges are rule-driven and time-sensitive, and many investors work with a Qualified Intermediary to ensure compliance. While complex, 1031 Exchanges remain a cornerstone strategy for investors seeking long-term, tax-efficient portfolio growth.
Opportunity Zones Program
The Opportunity Zones program was designed to encourage investment in designated economic development areas by offering preferential tax treatment.
By reinvesting eligible gains into Qualified Opportunity Zone investments, investors may receive:
- A partial reduction in capital gains taxes if the investment is held for five or seven years.
- Potential elimination of capital gains taxes on Opportunity Zone investment appreciation if held for ten years or more.
As with 1031 Exchanges, Opportunity Zone investments involve specific rules, risks, and structural considerations, but they can be a powerful tool when aligned with an investor’s objectives.
When It Makes Sense to Pay Capital Gains Taxes
While deferral strategies are attractive, they are not always the right choice.
If investors need liquidity for non-real-estate purposes — such as healthcare expenses, family obligations, or portfolio rebalancing — paying capital gains taxes and accessing proceeds immediately may be the more practical option. Similarly, market conditions or personal tax circumstances may reduce the relative benefit of deferral in certain situations.
The key is aligning tax strategy with broader financial goals, not pursuing deferral in isolation.
Getting the Right Advice
Capital gains taxes, depreciation, and deferral strategies can become increasingly complex as portfolios grow. Individual circumstances, filing status, and income levels all influence outcomes.
For this reason, commercial real estate investors are well served by working with experienced CPAs and tax professionals who understand real estate-specific tax rules. Proper guidance can help investors remain compliant while making informed decisions about timing, structure, and exit strategy.
Summary of Capital Gains Taxes on Commercial Real Estate
- Capital gains taxes apply to the profit realized when a commercial property is sold.
- Gains are calculated as the difference between the sales price and the property’s adjusted cost basis.
- Short-term gains are taxed as ordinary income; long-term gains benefit from lower tax rates.
- Depreciation reduces taxable income during ownership but is typically recaptured upon sale.
- Strategies such as 1031 Exchanges and Opportunity Zone investments may allow investors to defer capital gains taxes.
- Thoughtful planning — supported by professional advice — is essential to managing taxes and preserving long-term investment returns.
Understanding how capital gains on commercial real estate work is not just a tax exercise. It is a core component of disciplined investment decision-making and long-term portfolio strategy.
