How Commercial Real Estate Is Taxed When Selling a Business
If you’re thinking of cashing out the value you’ve built in a commercial real estate property over the years, you’ll need to consider the tax implications of that sale. In this article, you’ll discover how commercial real estate property is taxed when included in the sale of a business.
Are You Selling Commercial Real Estate for a Gain or Loss?
The main factor affecting your tax return when selling commercial real estate is whether you sell at a gain or loss.
If you sell a property for over and above its “adjusted basis,” the IRS recognizes this surplus as capital gains.
Conversely, you'll have a capital loss if you sell real estate for less than its adjusted cost basis.
What Is a Property’s Adjusted Basis?
Unless you acquired the commercial property as a gift or an inheritance, for which the IRS has a different way of determining the basis, a property’s basis is often its purchase price. This includes:
- The actual price you pay for the property
- Closing costs (including recording fees)
- Cost of interest
- Other legal/conveyance fees
To figure out your adjusted basis, however, you’ll need to add the cost of any capital improvements you’ve made to the property and subtract depreciation deductions and any insurance reimbursements you’ve received.
How Are Capital Gains From Real Estate Taxed?
If you have a capital gain on your real estate, which means your sales price is more than your adjusted basis, you’ll need to report this amount on Form 8949, Sales and Other Dispositions of Capital Assets, including your purchase and sales dates.
Remember that the IRS requires the purchase and sale dates to determine whether the capital gain is short-term or long-term. The IRS taxes these two things differently.
- Long-term capital gains tax rate: The IRS taxes long-term capital gains to property held for a year or more at rates lower than short-term capital gains, depending on your tax bracket.
- Short-term capital gains tax rates: On the flip side, the IRS taxes short-term capital gains to property held for less than one year at the marginal ordinary income tax rate.
Can You Offset a Capital Loss on Commercial Real Estate?
You can deduct the capital loss on real estate only against capital gains of the same type.
This means you can only offset a short-term capital loss against a short-term capital gain. The same principle applies to long-term capital gains.
But there’s some help.
Suppose you can’t fully offset your capital loss against the same kind of capital gain because of the size of your capital loss. In that case, the IRS allows taxpayers to offset up to $3,000 of the remaining loss against other types of income, including interest, salary, or even royalties. And you can carry any remaining loss forward and use it in subsequent years.
Opportunities to Lower Your Capital Gains Tax
While you may not lower your capital gains taxes, you can defer paying your capital gains taxes in two situations as follows.
1031 Exchange
Taking its name from Section 1031 of the tax code, this complex provision comes into play when you exchange investment or business real estate for a similar investment property without receiving any payment.
Alternatively, you can receive the cash proceeds through a qualified intermediary and use it to buy a qualified replacement within a designated timeline.
Section 1031 exchange rules are complicated, and mistakes can be costly. So consult with a qualified tax advisor.
Opportunity Zone Funds
Established by the 2017 Tax Cuts and Jobs Act, this is a type of real estate investment where you invest any realized capital gains into an Opportunity Zone Fund that buys new property in designated economically distressed communities. You’ll be able to defer your capital gains taxes until 2026.
Do State Taxes Apply When Selling Commercial Real Estate?
Yes. You may need to pay capital gains taxes to your state in addition to federal income tax.
Does Business Structure Affect Capital Gains Taxes?
Yes, business structure affects your tax bill. This is because the business structure will affect how the sale is structured—whether as an asset sale or stock sale—and hence how capital gains are calculated.
How About Depreciation Recapture?
Since depreciation lets you reduce your taxable income by a specified dollar amount each year, you’ll need to “recapture” these tax deductions when you sell a depreciated asset for a profit. The IRS will generally tax this amount at ordinary income tax rates.
Benefit of Having Expert Help with Real Estate Taxes
While there are parts you can navigate by yourself, real estate taxes can be pretty complex, especially where such items as depreciation recapture, Opportunity Zone Funds, or even 1031 exchanges come into play. Getting the help of a CPA or tax professional can give you some much-needed assurance.
Ensure compliance with tax laws and regulations by working with an accountant to help navigate the complexities of buying and selling a business. For more information on the tax implications of selling a business, head to the BizBuySell Taxes Learning Center.