Are There Capital Gains Taxes When Gifting Commercial Property? (w/Examples) + FAQs

No, a donor generally does not pay capital gains taxes at the moment they gift commercial property. However, this act of generosity creates a massive, hidden tax problem that is transferred directly to the person receiving the gift.

The core conflict stems from two competing sections of the U.S. tax code. The rule for gifts, Internal Revenue Code (IRC) § 1015, forces the recipient to inherit the donor’s original, low-cost basis, creating a ticking tax time bomb. This is the direct opposite of the rule for inheritances, IRC § 1014, which gives heirs a “stepped-up basis” that magically erases a lifetime of taxable gains. The immediate negative consequence is that a gift, intended to be a blessing, saddles the recipient with a significant future tax bill on decades of appreciation and depreciation they never personally benefited from.

This is not a minor issue; data suggests that unrealized capital gains make up a staggering 44% of the value in estates large enough to require filing an estate tax return. Gifting these assets instead of letting them pass through an estate means transferring that enormous tax liability to the next generation.

Here is what you will learn by reading this guide:

🎁 The Three Tax Traps: Discover how gift tax, capital gains tax, and depreciation recapture rules all collide when you transfer commercial property.
📜 The Million-Dollar Difference: Understand why inheriting property is almost always better for taxes than receiving it as a gift, thanks to the “stepped-up basis.”
⏰ The 2026 Tax Cliff: Learn why a major change in the estate tax exemption creates a limited-time window for strategic gifting right now.
mistakes Costly Mistakes to Avoid: Identify the top errors people make, from ignoring mortgage clauses to accidentally destroying valuable tax losses.
🗺️ Smarter Transfer Strategies: Explore advanced techniques using LLCs, Trusts, and charitable giving to achieve your goals with better tax outcomes.

The Three Tax Worlds That Collide When You Gift Property

When you gift a commercial building, you’re not just dealing with one set of rules. You’ve stepped into an intersection where three different types of federal taxes meet: gift tax, capital gains tax, and the special rules for commercial property. Understanding each one is the first step to avoiding a financial disaster.

What is the Federal Gift Tax, Really?

The federal gift tax is a tax on the transfer of property from one person to another without receiving something of equal value in return. The Internal Revenue Service (IRS) defines a gift very broadly. If you sell a building worth $1 million to your son for $100,000, you have made a gift of $900,000.

The person who gives the gift (the donor) is the one responsible for paying any gift tax that might be due. Luckily, most gifts don’t result in writing a check to the IRS because of two key exemptions.

First is the Annual Gift Tax Exclusion. For 2025, you can give up to $19,000 to any number of individuals without having to file a gift tax return. A married couple can combine their exclusions and give up to $38,000 per person, per year.

Second is the Lifetime Gift & Estate Tax Exemption. This is a much larger amount that you can give away over your entire life (or leave behind at death) before any tax is owed. For 2025, this exemption is a massive $13.99 million per person. If you give a gift that’s larger than the annual exclusion, you must file a gift tax return (Form 709), and the excess amount simply subtracts from your lifetime exemption.

How Capital Gains Tax Works: The Profit Tax

A capital gains tax is a tax on the profit you make from selling a “capital asset”. Nearly everything you own for investment purposes, including real estate, is a capital asset. The taxable profit is the difference between the sale price and the asset’s “adjusted basis”.

The tax rate you pay depends on how long you owned the property. If you owned it for more than one year, it’s a long-term capital gain, which is taxed at lower rates of 0%, 15%, or 20%, depending on your income. If you owned it for one year or less, it’s a short-term capital gain, taxed at your much higher ordinary income tax rates.

Your Adjusted Basis is the key number for calculating the gain. It starts with the original purchase price of the property. It then increases with the cost of any major improvements and decreases with any depreciation deductions you’ve claimed over the years.

What Makes “Commercial Property” Special for Taxes?

Commercial property is any real estate used for business, like office buildings, retail stores, or warehouses. The most important tax feature of commercial property is that you can depreciate it. The IRS allows you to deduct a portion of the building’s cost from your rental income each year to account for wear and tear.

For most commercial buildings, the cost is depreciated over a 39-year period using a straight-line method. While these annual deductions are great for lowering your taxable income each year, they come with a big catch. Every dollar of depreciation you claim reduces your adjusted basis in the property.

This creates a hidden tax liability. A lower basis means a bigger difference between the basis and the future sale price. That bigger difference translates directly into a larger taxable capital gain down the road.

The Donor’s Tax Trap: When a “Gift” Becomes a “Sale”

Most people assume giving property away is a simple, tax-free event for them. While that’s often true for a “pure” gift, two common situations can unexpectedly turn your act of generosity into a taxable sale in the eyes of the IRS, landing you a surprise tax bill.

The General Rule: Why a Pure Gift Doesn’t Trigger Capital Gains for You

In a simple, straightforward gift where you transfer a debt-free property and receive nothing in return, you do not realize a capital gain. A capital gain is only triggered when the “amount realized” from a sale is more than your adjusted basis. Since you received $0 for the gift, your “amount realized” is zero, and therefore, there is no gain for you to report on your income tax return.

Your only responsibility in this case is to file a gift tax return (Form 709) if the property’s value is more than the annual exclusion amount. The value of the gift will be subtracted from your lifetime exemption, but you won’t pay any immediate tax unless you’ve already used up your entire multi-million dollar exemption.

The Mortgage Trap: How Debt Relief Turns Your Gift into a Tax Bill

The most common and dangerous trap involves gifting a property that has a mortgage. When you gift a mortgaged property and the recipient takes over the debt, the IRS does not see this as a pure gift. Instead, it sees the debt relief you receive as a form of payment.

The amount of the mortgage that the recipient takes on is treated as an “amount realized” by you, the donor. This instantly converts the transaction into a part-sale, part-gift. If the amount of that mortgage debt is greater than your adjusted basis in the property, you will have an immediate, taxable capital gain.

Your Action	The IRS Consequence
You gift a commercial property with a $600,000 mortgage. Your adjusted basis is only $400,000 due to years of depreciation.	The IRS treats this as you “selling” the property for $600,000 (the debt relief). You have an immediate taxable capital gain of $200,000 ($600,000 – $400,000).

Beyond this tax problem, there’s a huge practical hurdle: the “due-on-sale” clause found in almost every mortgage contract. This clause gives the lender the right to demand the entire loan be paid off immediately if you transfer the property without their permission. An unauthorized gift could trigger a foreclosure.

The “Bargain Sale” Trap: Selling to Family for $1 Isn’t a Loophole

Another common mistake is trying to avoid gift rules by selling a valuable property to a family member for a very low price, like $1 or $10,000. The IRS sees right through this and reclassifies it as a “bargain sale,” which is another type of part-sale, part-gift transaction.

The IRS splits the transaction in two. The difference between the property’s Fair Market Value (FMV) and the low sale price is considered a taxable gift. The amount of cash you actually receive is treated as the proceeds from a sale, which can still trigger a capital gain for you if it’s more than your adjusted basis.

The “Gift That Keeps on Taking”: Understanding the Recipient’s Tax Nightmare

The biggest misconception about gifting property is that it avoids taxes. In reality, it doesn’t avoid them at all—it just defers and transfers the entire tax burden to the person you’re trying to help. The recipient inherits a complex and often massive tax liability that can turn the gift into a financial curse.

The Carryover Basis Rule: You Inherit the Donor’s Tax Problem

Under IRC § 1015, when you receive property as a gift, you also receive the donor’s adjusted basis in that property. This is known as a “carryover basis”. You are essentially stepping into the donor’s tax shoes, inheriting all the built-in appreciation that occurred over their years of ownership.

Imagine your father bought a commercial building for $200,000 twenty years ago. Today, it’s worth $1 million. If he gifts it to you, your basis isn’t the current $1 million value; it’s his original $200,000 basis.

If you decide to sell the building for $1 million, you will have a taxable capital gain of $800,000. The tax on that gain is your responsibility, even though the entire increase in value happened before you ever owned it. This is the “gift that keeps on taking”.

The Hidden Liability Bomb: Depreciation Recapture

For commercial property, the carryover basis rule comes with an even bigger problem: depreciation recapture. Over the years, the donor took depreciation deductions to lower their taxable rental income. The IRS views this as a tax benefit that must be “paid back” when the property is sold.

When a gifted commercial property is sold, a portion of the gain equal to the depreciation taken is taxed at a special, higher maximum federal rate of 25%. This is called “unrecaptured Section 1250 gain.”

The most unfair part of this rule is that the recipient, who never received the benefit of those annual depreciation deductions, is the one who has to pay the 25% recapture tax. The donor got years of tax breaks, and the recipient gets the bill. This hidden liability can easily amount to tens or even hundreds of thousands of dollars.

The Million-Dollar Question: Is It Better to Gift Property or Inherit It?

For property owners, the most critical strategic decision is whether to transfer a valuable asset during their lifetime or to let it pass to their heirs after death. The answer almost always comes down to the powerful difference between the carryover basis of a gift and the “stepped-up basis” of an inheritance.

The “Magic Eraser” of Taxes: The Stepped-Up Basis at Death

When you inherit property, IRC § 1014 provides one of the most powerful tax benefits in the entire code: the “stepped-up basis”. The heir’s basis in the property is not the original purchase price. Instead, it is “stepped up” to the full Fair Market Value of the property on the date of the original owner’s death.

This rule acts like a magic eraser for taxes. It permanently and legally wipes out all the capital gains that accumulated during the decedent’s lifetime. It also completely eliminates the entire depreciation recapture liability. The heir can sell the property the next day for its inherited value and owe zero federal income tax.

Gifting vs. Inheritance: A Side-by-Side Showdown

Let’s compare the outcomes for a property purchased for $200,000, which has accumulated $150,000 in depreciation, and is now worth $1 million.

For the vast majority of families, holding onto the property and allowing heirs to inherit it is by far the more tax-efficient strategy. Gifting should only be considered if your estate is large enough to be subject to the 40% federal estate tax.

The 2026 “Tax Cliff”: Why the Estate Tax Exemption Sunset Matters Now

There is one major reason why high-net-worth individuals are urgently considering large gifts right now. The Tax Cuts and Jobs Act of 2017 nearly doubled the lifetime gift and estate tax exemption. However, this provision is temporary and is set to “sunset” at the end of 2025.

Unless Congress acts, the exemption will be cut roughly in half, dropping from the current $13.99 million to an inflation-adjusted level of around $7 million in 2026. This creates a critical, time-sensitive window. For individuals with estates valued over this lower threshold, making large gifts before the end of 2025 allows them to use the current, much higher exemption to move assets out of their estate and save on future estate taxes.

Real-World Scenarios: Seeing the Tax Impact in Action

Abstract rules can be confusing. Let’s walk through three common scenarios to see how these tax laws play out with real numbers for a property purchased 20 years ago for $500,000, which has $200,000 in accumulated depreciation, and is now worth $1.5 million. The donor’s adjusted basis is $300,000 ($500k cost – $200k depreciation).

Scenario 1: The “Clean” Gift (No Mortgage)

A parent decides to gift the debt-free commercial property to their child.

The Parent’s Action	The Child’s Consequence
The parent gifts the $1.5M property. They file a gift tax return (Form 709) to report the gift, which reduces their lifetime exemption. They pay $0 in immediate capital gains tax.	The child receives the property with the parent’s $300,000 carryover basis. If the child sells it for $1.5M, they face a $1.2 million taxable gain, including a $200,000 depreciation recapture taxed at 25%.

Scenario 2: The Mortgaged Property Gift

The same property now has a $700,000 mortgage that the child agrees to take over.

The Parent’s Action	The Immediate & Future Consequences
The parent gifts the property. The IRS sees the $700,000 mortgage relief as a sale. The parent has an immediate $400,000 taxable capital gain ($700k mortgage – $300k basis).	The child’s basis is now $700,000 (the debt assumed). If they sell for $1.5M, they still face an $800,000 taxable gain. The parent’s gift created an immediate tax bill for them and a future one for their child.

Scenario 3: The Inheritance “Golden Ticket”

Instead of gifting, the parent holds the property until they pass away. The child inherits it.

The Parent’s Action	The Child’s Consequence
The parent holds the property, which is valued at $1.5M in their estate. The estate may or may not owe estate tax, depending on the parent’s total net worth.	The child inherits the property and receives a stepped-up basis of $1.5 million. If the child sells it for $1.5M, their taxable gain is $0. All capital gains and depreciation recapture are permanently erased.

Top 5 Mistakes to Avoid When Gifting Commercial Property

Transferring commercial property can be a minefield of costly errors. Being aware of these common mistakes can save you and your family from unexpected tax bills, legal troubles, and financial hardship.

Ignoring the Mortgage’s “Due-on-Sale” Clause. Gifting a property with a mortgage without the lender’s written permission can be a catastrophic mistake. This clause allows the bank to demand the entire loan balance be paid immediately, potentially forcing a sale or foreclosure. Always talk to the lender first.
Forgetting About Carryover Basis and Depreciation Recapture. This is the most common and expensive tax mistake. Donors focus on avoiding gift tax and completely forget they are passing on a massive income tax liability to the recipient through the carryover basis and the 25% depreciation recapture tax.
Gifting Property That Has a Loss. It is almost always a bad idea to gift property that is worth less than its adjusted basis. If you gift it, the recipient’s basis for calculating a future loss is the lower fair market value at the time of the gift, which can completely eliminate the tax benefit of the loss. The better strategy is for you to sell the property, take the capital loss on your own tax return, and then gift the cash.
Failing to Get a Qualified Appraisal. When you file a gift tax return for a property, you must report its Fair Market Value. The IRS requires you to get a “qualified appraisal” from an independent, qualified appraiser to support this value. Skipping this step can lead to IRS challenges, penalties, and a revaluation of your gift.
Ignoring State and Local Taxes. Federal tax law is only part of the picture. The transaction could be subject to state capital gains taxes for the recipient, and many states and cities impose real estate “transfer taxes” that must be paid when the deed is recorded, even if no money changes hands.

Advanced Gifting Strategies: More Control and Better Tax Outcomes

Beyond a simple transfer of the deed, sophisticated strategies using legal structures like LLCs and trusts can offer greater control, liability protection, and more efficient tax results.

Using an LLC for Smarter Gifting

Instead of gifting the property directly, you can first place it into a Limited Liability Company (LLC). Contributing property to an LLC you control is generally a tax-free event under IRC § 721. This structure provides two major advantages for gifting.

First, it allows you to gift small ownership interests in the LLC over many years. This lets you use your annual gift tax exclusion ($19,000 per person for 2025) to gradually transfer value without eating into your lifetime exemption. Second, gifts of minority interests in a private LLC may qualify for valuation discounts for “lack of control” and “lack of marketability,” allowing you to transfer more underlying asset value for each dollar of your exemption.

The Power of Trusts: Revocable vs. Irrevocable

Trusts are powerful tools for managing and transferring assets.

Revocable Living Trust: Transferring property to a revocable trust is not considered a gift for tax purposes because you retain full control. The property remains part of your estate, which means your beneficiaries will receive the coveted stepped-up basis at your death. A revocable trust is an excellent tool for avoiding the costly and time-consuming probate process, not for saving on taxes.
Irrevocable Trust: Transferring property to an irrevocable trust is a completed gift. This move successfully removes the asset and its future appreciation from your taxable estate. However, it comes with the standard gifting trade-off: the trust receives a carryover basis, preserving the built-in capital gains and depreciation recapture liability for its beneficiaries.

The Ultimate Tax Win: Gifting to Charity

For property owners who are charitably inclined, donating appreciated commercial real estate can be the single most tax-efficient way to dispose of the asset. A direct donation to a qualified public charity, like a Donor-Advised Fund, provides a powerful double tax benefit.

First, you generally avoid paying any capital gains tax and depreciation recapture on the property’s appreciation. Second, you may be entitled to a charitable income tax deduction for the full Fair Market Value of the property. This strategy allows you to support a cause you care about while simultaneously eliminating a major tax liability and generating a new tax deduction.

The Paperwork Trail: A Step-by-Step Guide to IRS Form 709

Anytime you make a gift that exceeds the annual exclusion amount ($19,000 for 2025), you must report it to the IRS by filing Form 709, the U.S. Gift Tax Return. This form is how the IRS tracks the gifts you make against your lifetime exemption. It is filed by the donor, not the recipient, and is due by April 15th of the year following the gift.

Here is a breakdown of the key parts of the form:

Part 1 – General Information: This is where you, the donor, enter your personal details like name, address, and Social Security number. You will also indicate if you are “splitting” gifts with your spouse, which allows you to combine your annual exclusions.
Schedule A – Computation of Taxable Gifts: This is the heart of the return where you list every reportable gift you made during the year. For each gift of property, you must provide:
- Donee’s Name and Address: Who received the gift.
- Description of Gift: A detailed legal description of the property.
- Donor’s Adjusted Basis of Gift (Column e): This is a critical field. You must report your adjusted basis in the property at the time of the gift.
- Date of Gift (Column f): The date the transfer was completed.
- Value at Date of Gift (Column g): The Fair Market Value of the property on the date of the gift. This value must be supported by a qualified appraisal, a copy of which should be attached to the return.
Schedule A, Part 4 – Taxable Gift Reconciliation: This section is where you total your gifts, subtract the annual exclusions you are allowed, and arrive at the total taxable gifts for the year.
Part 2 – Tax Computation: This section calculates any potential gift tax. It takes your taxable gifts for the current year, adds them to all the taxable gifts you’ve made in prior years, and computes a tentative tax. It then subtracts the tax on prior gifts and applies your unified credit (the tax value of your lifetime exemption) to determine if any tax is actually due. For most people, the result will be zero tax owed, but filing the form is still mandatory to properly reduce the remaining lifetime exemption.

Beyond the IRS: How State Taxes Can Change the Game

Federal tax laws are only one piece of the puzzle. Each state has its own set of rules for property and income taxes, which can add another layer of cost and complexity to your gift. You must consider these state-specific nuances before making any transfer.

States With No Capital Gains Tax: The Big Winners

A handful of states are exceptionally tax-friendly because they do not impose any state-level capital gains tax. These states include Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. If the recipient of your gift lives in one of these states, their future tax bill from selling the property will be limited to federal taxes only, which is a significant advantage.

States That Tax Gains as Ordinary Income: The Highest Burden

Some states do not offer preferential treatment for long-term capital gains. Instead, they tax these gains at the same high rates as ordinary income, such as wages and salaries. This can dramatically increase the overall tax burden on the recipient when they eventually sell the gifted property.

The Middle Ground: States with Preferential Rates

Many states fall somewhere in between, taxing long-term capital gains but at rates lower than their top ordinary income tax rates. States like Arizona, Arkansas, Hawaii, Montana, New Mexico, North Dakota, and Wisconsin offer some form of tax break for capital gains. For example, Washington state has a capital gains tax but specifically exempts all sales of real estate, whether commercial or residential.

Don’t Forget Transfer Taxes and State Gift Taxes

Beyond capital gains, two other state-level taxes can impact your gift. Many states and local counties impose real estate transfer taxes on the recording of a new deed. These fees are often based on the property’s value and can be due even when no money is exchanged.

Finally, while most states do not have a gift tax, Connecticut is the sole exception and imposes its own state-level gift tax. For residents of other states that have a state estate tax (like New York or Massachusetts), this absence of a state gift tax creates a planning opportunity. Making large lifetime gifts can remove assets from your estate, saving on future state estate taxes without incurring a current state gift tax.

Gifting Commercial Property: Pros and Cons at a Glance

Deciding whether to gift a commercial property is a major financial decision with significant benefits and drawbacks. This table summarizes the key points to help you weigh your options.

Pros (Advantages of Gifting)	Cons (Disadvantages of Gifting)
Removes Asset from Your Estate: A completed gift removes the property and its future appreciation from your taxable estate, potentially saving on federal estate taxes if your estate is very large.	Recipient Gets Carryover Basis: The recipient inherits your low-cost basis, creating a large, built-in capital gain for them when they sell.[16, 18]
See Your Heirs Enjoy the Gift: Gifting allows you to help your loved ones during your lifetime and see them benefit from the property.	Recipient Inherits Depreciation Recapture: The recipient is stuck with the tax bill for all the depreciation you claimed, taxed at a 25% rate.
Leverage the High Lifetime Exemption: You can use the current, historically high lifetime gift tax exemption before it is scheduled to be cut in half in 2026.	Loss of Stepped-Up Basis: Gifting irrevocably forfeits the most valuable tax benefit available: the stepped-up basis at death that eliminates all capital gains.[16, 17]
Reduce Property Management Burden: Gifting can relieve you of the day-to-day responsibilities and costs of managing a commercial property.	Potential for Immediate Donor Tax: If the property has a mortgage greater than your basis, the gift will trigger an immediate capital gains tax for you, the donor.
Asset Protection for the Donor: Once gifted, the property is generally shielded from your future personal creditors.	Loss of Control: Once you gift the property, you give up all legal control over how it is used, managed, or sold.[40]

Frequently Asked Questions (FAQs)

1. Does the person receiving the gifted property have to pay tax immediately? No. The receipt of a gift is not considered taxable income. The tax consequences for the recipient are deferred until they sell the property, at which point they will owe capital gains tax.

2. Who files the gift tax return (Form 709)? Yes. The donor (the person giving the gift) is legally responsible for filing Form 709 and paying any gift tax that may be due. The recipient has no filing requirement.

3. What if I gift property that has lost value? No, this is usually a bad idea. A special rule applies that can eliminate the tax benefit of the capital loss. It is better for you to sell the property, claim the loss, and then gift the cash.

4. Can I gift a property that has a mortgage on it? Yes, but it’s complicated. The gift may trigger an immediate capital gains tax for you if the mortgage exceeds your basis. Your lender must also approve the transfer to avoid triggering a “due-on-sale” clause.

5. How is the holding period determined for the recipient? Yes. The recipient is allowed to “tack on” the donor’s holding period. This ensures that any gain on a future sale will almost always qualify for lower long-term capital gains tax rates.

6. Is it better to gift commercial property or to inherit it? No, from a tax standpoint, inheriting is almost always better. Inheritance provides a “stepped-up basis,” which completely eliminates capital gains tax and depreciation recapture on all appreciation that occurred during the owner’s life.

7. What happens to all the depreciation the donor took over the years? Yes. The full tax liability for that depreciation, known as “depreciation recapture,” is transferred to the recipient. They will have to pay a 25% tax on that portion of the gain when they sell the property.

8. Can I avoid taxes by selling my property to my child for $1? No. The IRS will reclassify this as a “bargain sale.” The difference between the property’s fair market value and the $1 price is a gift, and the $1 sale could still trigger a capital gain for you.

9. Is it different if I gift the property to a charity instead of a person? Yes. Gifting appreciated property to a qualified charity is highly tax-efficient. It generally allows you to avoid capital gains tax entirely and also receive a charitable income tax deduction for the property’s full market value.

10. Do I need to get the property appraised before I gift it? Yes. For any gift of real estate that requires filing Form 709, you must obtain a qualified appraisal to establish the property’s Fair Market Value on the date of the gift.

11. Do state taxes apply to gifted property? Yes. The transaction could be subject to state or local real estate transfer taxes. The recipient will also have to pay state capital gains tax (unless they live in a state with no income tax) upon selling.

12. What is the “unified credit”? Yes. The unified credit is the lifetime exemption ($13.99 million in 2025) expressed as a dollar-for-dollar tax credit. It is “unified” because it applies against both gift taxes during life and estate taxes at death.

13. Why does the 2026 “sunset” matter for gifting? Yes. The current high lifetime gift and estate tax exemption is scheduled to be cut in half in 2026. This creates a limited-time opportunity for wealthy individuals to gift large amounts using today’s higher exemption.

14. If my spouse and I own property together, can we both make a gift? Yes. You can “split” the gift. This allows you to combine your annual exclusions, letting you give up to $38,000 (in 2025) to a single person each year without needing to file a gift tax return.

15. Does the recipient’s basis ever change from the donor’s basis? Yes. The recipient’s basis can be increased by the portion of any gift tax the donor paid that is attributable to the property’s appreciation. This is a complex calculation and usually provides only a small adjustment.