Table of Contents
How to Avoid Capital Gains Tax on the Sale of Commercial Property?
What Is Capital Gains Tax?
Capital Gains Tax (CGT) is a federal tax levied on the profit realized from the sale of a capital asset, such as commercial real estate. The tax rate depends on how long the asset was held before sale and the taxpayer’s income level.
When Does Capital Gains Tax Apply?
Capital gains tax applies when you sell a commercial property for more than its adjusted basis (original purchase price plus improvements minus depreciation). The gain is classified as either short-term or long-term, depending on the holding period.
1. Utilize the Section 121 Exclusion
While primarily applicable to primary residences, if part of your commercial property was used as your main home, you might qualify for the Section 121 exclusion, allowing you to exclude up to $250,000 ($500,000 for married couples) of gain.
2. Offset Gains with Losses
If you have capital losses from other investments, you can use them to offset your capital gains, thereby reducing your taxable gain.
3. Gift Assets to Your Spouse
Transferring ownership to a spouse can be a tax-efficient strategy, especially if they are in a lower tax bracket. However, this must be done in compliance with IRS rules to avoid gift tax implications.
4. Reduce Taxable Income
Lowering your overall taxable income can place you in a lower capital gains tax bracket. Strategies include maximizing deductions and contributing to retirement accounts.
5. Buying and Selling Within the Family
Selling property to a family member at a lower price can reduce capital gains, but the IRS scrutinizes such transactions to ensure they are conducted at fair market value.
6. Contribute to a Pension
Contributions to retirement plans like 401(k)s or IRAs can reduce your taxable income, potentially lowering your capital gains tax rate.
7. Make Charity Donations
Donating appreciated property to a qualified charity can provide a charitable deduction and eliminate the capital gains tax on the donated asset.
8. Spread Gains Over Tax Years
Structuring the sale as an installment sale allows you to spread the gain over several years, potentially keeping you in a lower tax bracket.
9. Maximizing Tax-Efficient Investments
Investing in tax-efficient vehicles, such as certain mutual funds or ETFs, can minimize capital gains distributions and associated taxes.
10. Invest in Small Companies
Investing in Qualified Small Business Stock (QSBS) can offer significant tax exclusions on capital gains if specific criteria are met.
Who Needs to Pay CGT on Commercial Property?
Any individual or entity that sells a commercial property at a profit is subject to capital gains tax. This includes sole proprietors, partnerships, corporations, and trusts.
Capital Gains Tax Over the Years
The capital gains tax rates have evolved over time. Here’s a brief overview:
- 2008–2010: Flat rate of 18%.
- 2010–2011: 18% and 28% for individuals; 28% for trusts; 10% for gains qualifying for entrepreneurs’ relief.
- 2011–2016: Same as above.
- 2016–2017: 10% and 20% for individuals (excluding residential property); 18% and 28% for residential property; 20% for trusts; 10% for entrepreneurs’ relief.
- 2017 onwards: 0%, 15%, and 20% rates based on income levels; additional 3.8% Net Investment Income Tax may apply to high earners.
2025 Federal Capital Gains Tax Rates
Short-Term Capital Gains
- Definition: Profits from the sale of assets held one year or less.
- Tax Treatment: Taxed as ordinary income, with rates ranging from 10% to 37%, depending on your taxable income and filing status.
Long-Term Capital Gains
- Definition: Profits from the sale of assets held more than one year.
- Tax Treatment: Taxed at preferential rates of 0%, 15%, or 20%, based on your taxable income and filing status.
Range and Implications
Short-Term Capital Gains
Short-term capital gains occur when a commercial property is sold after being held for one year or less. These gains are taxed as ordinary income tax rates, which can range from 10% to 37%, depending on your filing status and total taxable income.
Calculation of Short-Term Capital Gains:
Formula:
STCG = Sale Price – (Purchase Price + Expenses Incurred on Sale)
Example:
- Purchase Price: $600,000
- Sale Price: $750,000
- Expenses (legal, broker fees): $25,000
- STCG = $750,000 – ($600,000 + $25,000) = $125,000
If the taxpayer is in the 35% tax bracket, the federal tax owed is:
$125,000 × 35% = $43,750
This is significantly higher than long-term capital gains rates, which is why timing matters.
Long-Term Capital Gains
Long-term capital gains apply when a property is sold after being held for more than one year. These are taxed at preferential rates based on income brackets.
Calculation of Long-Term Capital Gains:
Formula:
LTCG = Sale Price – Indexed Cost of Acquisition – Expenses Incurred on Sale
Unlike short-term gains, this formula considers the adjusted or indexed cost basis, especially when significant improvements or depreciation were involved.
Example:
- Purchase Price: $600,000
- Adjusted Cost (including depreciation and improvements): $650,000
- Sale Price: $900,000
- Expenses: $30,000
- LTCG = $900,000 – $650,000 – $30,000 = $220,000
Short-Term vs. Long-Term Capital Gains Tax:
Feature | Short-Term | Long-Term |
Holding Period | 1 year or less | More than 1 year |
Tax Rate | Ordinary income (10%–37%) | Preferential rates (0%, 15%, or 20%) |
Impact | Higher tax burden | Lower tax liability |
Planning Strategy | Avoid quick flips | Hold longer to reduce tax |
2025 Short-Term Capital Gains Tax Rates
Short-term gains are taxed according to your income tax bracket:
Filing Status | Taxable Income | Marginal Rate Applied to STCG |
Single | Up to $11,600 | 10% |
Single | $11,601 – $47,150 | 12% |
Single | $47,151 – $100,525 | 22% |
Single | $100,526 – $191,950 | 24% |
Single | $191,951 – $243,725 | 32% |
Single | $243,726 – $609,350 | 35% |
Single | Over $609,350 | 37% |
These rates apply directly to short-term capital gains.
2025 Long-Term Capital Gains Tax Rates
These apply federally and depend on filing status and income thresholds:
Filing Status | Income Range | LTCG Tax Rate |
Single | Up to $48,350 | 0% |
Single | $48,351 – $533,400 | 15% |
Single | Over $533,400 | 20% |
Married Filing Jointly | Up to $96,700 | 0% |
Married Filing Jointly | $96,701 – $600,050 | 15% |
Married Filing Jointly | Over $600,050 | 20% |
Head of Household | Up to $64,750 | 0% |
Head of Household | $64,751 – $566,700 | 15% |
Head of Household | Over $566,700 | 20% |
Savings Through Long-Term Holding
Suppose that you’re a single filer with taxable income of $150,000. Here’s how your capital gains are taxed:
- Short-Term Sale: Gains are taxed at 24%
- Long-Term Sale: Gains taxed at 15%
Savings: You save 9% on the entire profit—on $200,000 gain, that’s $18,000 in tax savings.
This demonstrates why holding your commercial property for over one year is one of the most effective tax-saving strategies.
Tax-Free Limits and Filing Status
Understanding your filing status is crucial, as it determines the income thresholds for capital gains tax rates. Proper planning can help you stay within lower tax brackets.
Limitations and Exceptions
Certain situations, such as the sale of collectibles or real estate with depreciation, may be subject to different tax rates or rules. Always consult with a tax professional to understand specific implications.
Impact on Tax Payments
Capital gains can significantly impact your tax liability. Strategic planning, such as timing the sale and utilizing tax-advantaged accounts, can mitigate this impact.
How to Avoid Capital Gains Tax on Sale of Commercial Property
1. 1031 Exchange
A 1031 exchange allows you to defer capital gains tax by reinvesting the proceeds from the sale into a similar property.
2. Timing the Sale of Your Property
Selling in a year when your taxable income is lower can reduce your capital gains tax liability. Since long-term capital gains tax rates are based on income thresholds, timing the sale strategically—such as after retirement, during a gap year, or after taking deductions—can help you remain within a lower tax bracket, potentially qualifying for the 0% or 15% capital gains tax rates.
3. Opportunity Zone Investments
The Opportunity Zones program, established under the Tax Cuts and Jobs Act of 2017, allows investors to defer and potentially eliminate capital gains taxes by reinvesting those gains into Qualified Opportunity Funds (QOFs). If you hold your QOF investment for:
- 5 years: You may reduce your deferred capital gain by 10%.
- 7 years: You may reduce it by an additional 5%, for a total of 15%.
- 10 years or more: All post-investment gains on the QOF are completely tax-free.
4. Converting Property to a Primary Residence
If the commercial property was partially used for personal purposes, you may qualify for a partial Section 121 exclusion after converting it to your primary residence and living there for at least 2 of the past 5 years. This allows you to exclude up to $250,000 of capital gains ($500,000 if married filing jointly).
5. Investing Through Retirement Accounts
Although retirement accounts like IRAs or 401(k)s cannot directly hold real property under typical custodians, investing through self-directed IRAs (SDIRAs) or Solo 401(k)s can shelter real estate gains. Profits from property sales inside these accounts grow tax-deferred or tax-free (in Roth structures).
6. Installment Sale
By spreading the sale proceeds over multiple years, an installment sale lets you recognize gains gradually, possibly keeping you in a lower tax bracket each year. This strategy spreads your capital gains over several tax periods, easing your tax burden and helping with cash flow planning.
7. Offset Gains With Losses
Known as tax-loss harvesting, this technique involves selling underperforming investments to realize capital losses, which can be used to offset capital gains. The IRS allows:
- Up to $3,000 of net capital losses to reduce ordinary income annually.
- Unlimited carryover of excess losses to future years.
8. Reporting and Compliance
Failure to report capital gains accurately can result in penalties and interest. Use Form 8949 and Schedule D when filing taxes. Keep comprehensive records of:
- Purchase and sale dates
- Original price
- Capital improvements
- Selling expenses
- Depreciation claimed
9. Charitable Donations
Donating appreciated commercial property to a qualified charitable organization allows you to:
- Avoid capital gains tax
- Claim a charitable deduction for the fair market value of the property
This is particularly effective for highly appreciated assets that are otherwise difficult to sell without incurring significant tax liability.
10. Consult a Tax Professional
Because commercial real estate and capital gains are complex and frequently audited, consult a CPA or tax attorney before executing any sale or deferral strategy. They can help structure deals that minimize your tax exposure while ensuring compliance with IRS regulations.
Beware of Depreciation Recapture Tax
When you sell commercial property that you’ve depreciated, the IRS requires you to recapture that depreciation as ordinary income, which can be taxed at a higher rate than long-term capital gains.
Depreciation Recapture Implications | Details |
Higher Tax Rates | Depreciation is taxed as ordinary income, not at the lower capital gains rate. |
Impact on Profitability | Can significantly reduce the after-tax proceeds from the sale. |
To reduce the hit, consider 1031 exchanges, cost segregation studies, or increasing your basis through property upgrades and reinvestment.
How To Avoid Capital Gain Tax on Inherited Property
- Step-up in basis applies: Heirs receive the property with a new basis equal to the fair market value at the date of death.
- Selling immediately after inheriting the property often results in minimal or zero taxable gain.
- If the property appreciates after the inheritance, only that post-inheritance gain is taxable.
This makes inherited property far more tax-efficient to sell than assets acquired during your lifetime.
How To Avoid Capital Gain Tax on Overseas Property
Selling foreign commercial property can also trigger U.S. capital gains tax if you are a U.S. taxpayer. Strategies include:
- Utilizing the Foreign Tax Credit (Form 1116) if you paid taxes in the country of sale.
- Claiming a deduction for foreign taxes paid, instead of a credit (whichever results in lower overall tax).
- Structuring the sale to qualify for long-term capital gains treatment.
- Investing proceeds in U.S. Opportunity Zones or through 1031-like deferral if applicable.
Note: The FATCA and FBAR regulations still require U.S. persons to disclose foreign financial assets, including real estate held through foreign corporations or partnerships.
Last But Not Least: Avoid Capital Gains Tax on the Sale of Commercial Property
Navigating the U.S. tax system can be overwhelming, especially when significant profits are involved. Understanding how to avoid capital gains tax on sale of commercial property is not about exploiting loopholes — it’s about using legal, IRS-approved strategies to maximize your net returns and minimize liabilities.
From leveraging a 1031 exchange, installment sale agreements, and opportunity zones, to offsetting with capital losses or charitable donations, the tools at your disposal are diverse. Add to that the benefits of long-term holdings, retirement contributions, and professional tax guidance, and you’re empowered to plan smarter, not harder.
Don’t let your gains be eroded by poor timing or unawareness. The right tax strategy, tailored to your property portfolio and future goals, can make a significant difference — now and in the long run.
If you’re still unsure about how to avoid capital gains tax on sale of commercial property, consult a licensed tax advisor and make sure your approach is fully compliant, efficient, and strategically aligned with your growth.
Frequently Asked Questions (FAQs)
1: What is capital gains tax on commercial property?
Capital gains tax (CGT) is a tax on the profit made from the sale of commercial property. It is calculated as the difference between the sale price and the adjusted basis (purchase price + improvements – depreciation).
2: How can I legally avoid capital gains tax on the sale of commercial property?
There are several strategies to legally avoid or defer capital gains tax, including using a 1031 exchange, making charitable donations, offsetting gains with capital losses, or investing in opportunity zones.
3: What is a 1031 exchange and how does it help avoid capital gains tax?
A 1031 exchange allows you to defer capital gains taxes by reinvesting the proceeds from the sale of one property into another like-kind property within a specific time frame, as per IRS guidelines.
4: How long must I hold a commercial property to benefit from long-term capital gains tax rates?
To benefit from long-term capital gains tax rates, the property must be held for at least one year. Gains from properties held for less than a year are considered short-term and taxed at a higher rate.
5: What is the difference between short-term and long-term capital gains tax?
Short-term capital gains (assets held for one year or less) are taxed at ordinary income rates (up to 37%), while long-term capital gains (assets held for more than one year) are taxed at a reduced rate of 0%, 15%, or 20%, depending on income level.
6: Can I avoid capital gains tax by converting my commercial property into a primary residence?
Yes, if you convert your commercial property into a primary residence and live in it for at least 2 out of 5 years, you may qualify for a partial capital gains exclusion under Section 121 of the IRS code.
7: How does depreciation recapture affect capital gains tax on commercial property?
Depreciation recapture occurs when you sell a property that has been depreciated. The IRS taxes the depreciated portion of the sale at ordinary income tax rates (up to 25%), which may increase your tax burden.
8: Can I offset capital gains with losses from other investments?
Yes, you can use capital losses from other investments to offset capital gains from the sale of commercial property. This strategy, known as tax-loss harvesting, helps reduce the overall tax impact.
9: How do opportunity zone investments help avoid capital gains tax?
Investing in Opportunity Zones can provide significant tax deferrals. If you reinvest your capital gains into a Qualified Opportunity Fund (QOF), you can defer taxes on those gains until 2026. If held for 10+ years, the gains from QOF investments are tax-free.
10: Should I consult a tax professional before selling my commercial property?
Absolutely. Consulting a tax professional ensures you make informed decisions regarding tax-saving strategies, IRS compliance, and the best way to structure your property sale to minimize taxes.
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