Selling a commercial property can trigger significant capital gains taxes—but savvy investors use legal strategies to minimize or defer those taxes.
According to IRS data, in 2022 U.S. commercial property sales generated over $60 billion in capital gains, leaving sellers facing steep tax bills without strategic planning. Fortunately, there are perfectly legal ways to avoid or defer paying capital gains tax when you sell a commercial property. In this comprehensive guide, we’ll explore proven tax-saving strategies, explain federal and state rules, and provide real-world examples so you can keep more of your hard-earned profits.
- 💰 What capital gains tax is and how it can drastically cut into your commercial property sale profits—plus why depreciation recapture makes it even more costly.
- 🔄 Proven strategies (1031 exchanges, Opportunity Zone funds, installment sales, charitable trusts) to defer or even avoid capital gains taxes legally and maximize your net returns.
- 🗺️ How federal capital gains tax rules differ from state taxes, with key nuances in high-tax states like California and New York versus tax-free states like Texas and Florida.
- ⚠️ Common mistakes that trigger unnecessary taxes—such as missing 1031 deadlines or not using a qualified intermediary—and how to avoid these costly pitfalls.
- 🤔 Real-world scenarios comparing outcomes of different tax strategies, plus a handy FAQ answering the burning questions investors ask about saving on capital gains taxes.
Understanding Capital Gains Tax on Commercial Property
What Is Capital Gains Tax (and When Does It Apply)?
Capital gains tax is a tax on the profit you make when you sell an asset for more than you paid for it. In real estate, your capital gain is essentially the difference between the property’s selling price and your adjusted cost basis (what you originally paid, plus certain improvements and minus depreciation taken). If you sell a commercial building for a profit, the IRS expects you to report and pay tax on that gain.
There are two types of capital gains: short-term (if you owned the property for one year or less) and long-term (if owned for more than one year). Short-term gains are taxed at your ordinary income tax rate (which can be as high as 37% federally), while long-term gains benefit from lower federal tax rates (typically 15% for many investors, or 20% for high earners). Most commercial property sales qualify as long-term gains if the property was held for over a year. This means selling a highly appreciated building could result in a tax bill of tens or even hundreds of thousands of dollars in federal capital gains taxes alone.
How Commercial Real Estate Gains Are Taxed (Depreciation Recapture and More)
Commercial real estate often comes with an extra tax wrinkle: depreciation recapture. When you own investment property, you usually depreciate the building over time on your tax returns (commercial buildings are depreciated over 39 years). This depreciation lowers your taxable income during ownership but also lowers your property’s tax basis. When you sell, the IRS “recaptures” this benefit by taxing the portion of your gain equal to the depreciation you claimed at a special federal rate (up to 25%, higher than the typical long-term capital gains rate).
For example, imagine you bought a warehouse years ago for $500,000 and claimed $150,000 in depreciation over the years, so your adjusted basis is now $350,000. If you sell the property for $600,000, your total gain is $250,000. Of that gain, $150,000 is attributable to depreciation (recaptured at 25%), and the remaining $100,000 is a regular long-term capital gain (taxed at 15% or 20% depending on your income). In addition, high-income investors may owe the 3.8% Net Investment Income Tax (NIIT) on top of those rates. As you can see, these taxes add up and can take a big bite out of your sale proceeds.
Legally Avoiding or Deferring Capital Gains Tax: Key Strategies
Paying a huge tax bill isn’t the only option when you sell. The U.S. tax code provides several legal strategies to avoid or defer capital gains tax on the sale of commercial property. The idea is to either defer recognition of the gain to a later time or offset it in special ways. Below are the most commonly used methods:
1. 1031 Like-Kind Exchange (Swap Instead of Sell)
A 1031 exchange (named after Section 1031 of the Internal Revenue Code) is one of the most powerful tools for real estate investors to defer capital gains taxes. Often summarized as “swap, don’t sell,” a 1031 exchange allows you to sell your commercial property and reinvest the proceeds into another like-kind property of equal or greater value, without paying taxes on the sale. Essentially, the IRS treats it as a continuous investment rather than a taxable sale, so the capital gain is deferred (carried over into the new property).
How it works: You must follow strict rules. First, you cannot take possession of the sale proceeds—doing so will trigger the tax. Instead, you hire a Qualified Intermediary (QI) (a specialized middleman) to hold the funds from your sale. You then have 45 days from the sale to identify potential replacement properties and 180 days from the sale to complete the purchase of the new property. The replacement property must be of equal or greater value and used for business or investment (you can’t 1031 exchange into a personal-use property).
If done correctly, a 1031 exchange lets you defer 100% of the capital gains tax (including depreciation recapture) from the sale. This means you can roll the entire equity into a new investment property, giving you more buying power. Investors often repeat this process multiple times (“trading up” to bigger properties) and can essentially keep deferring indefinitely. The phrase “swap ‘til you drop” refers to the strategy of continuing 1031 exchanges until the investor’s death, at which point their heirs receive a stepped-up basis (resetting the property’s value to the current market value, effectively wiping out the deferred gain for income tax purposes).
Pros: A 1031 exchange defers taxes and allows your investment capital to grow tax-free until you cash out. You can diversify or consolidate portfolios by exchanging into different properties. It’s a well-established, IRS-sanctioned process widely used in commercial real estate.
Cons: The rules and timelines are rigid. Failing to identify a property in 45 days or close in 180 days will disqualify the exchange and make the sale fully taxable. You also need to reinvest all the cash and maintain or increase the debt level on the new property; any cash you keep or debt you don’t replace becomes taxable boot. Additionally, 1031 exchanges typically involve transaction costs and complexity, and you might feel pressure to find a suitable property quickly to meet the deadlines.
2. Investing in Qualified Opportunity Zones (Tax Deferral and Potential Tax-Free Growth)
The Opportunity Zone (OZ) program, created by the Tax Cuts and Jobs Act of 2017, offers another way to defer and even reduce capital gains tax, while incentivizing investment in designated low-income communities. If you sell a commercial property (or any asset with a capital gain) and invest the gain portion into a Qualified Opportunity Fund (QOF) within 180 days, you can defer paying tax on that gain until as late as December 31, 2026. The QOF then uses the money to invest in businesses or real estate projects located in Qualified Opportunity Zones across the U.S.
Key benefits: By deferring the original capital gain until 2026, you postpone the tax payment for several years. Originally, the law also allowed a portion of the deferred gain to be forgiven (a 10% reduction if you invested by 2021 and held for 5 years), but that benefit has phased out for new investments since we are past those deadlines. However, the biggest incentive is that if your money stays invested in the Opportunity Zone fund for at least 10 years, any new gains on the Opportunity Zone investment itself can be 100% tax-free. In other words, you pay the deferred tax on your original sale in 2026, but the appreciation that your Opportunity Zone investment earns over a decade can be realized with no capital gains tax at all.
Considerations: Opportunity Zones can be powerful, but they come with risks and conditions. You must invest through a qualifying fund—meaning you have less direct control over the investment (you’re typically investing in a fund or project managed by others). The projects are often in economically distressed areas, which can mean higher risk or longer timelines for returns. Also, not every state conforms to the federal OZ tax benefits (for example, California does not provide state tax deferral for Opportunity Zone investments, so you’d still owe California tax on the gain even if it’s deferred federally). And importantly, the deferral on your original gain is temporary: you will have to pay that deferred tax by 2027 at the latest (for tax year 2026). Always perform due diligence on the Opportunity Fund and ensure it’s a qualified fund to get the tax benefits.
3. Installment Sale (Spreading Out the Gain Over Time)
An installment sale is a classic seller-financing strategy that can ease the tax hit by spreading it over several years. Instead of selling your commercial property for a lump sum, you, as the seller, agree to finance the buyer’s purchase (in whole or part) and receive the proceeds in installments over time (for example, payments over five or ten years). Under Section 453 of the tax code, you pay capital gains tax proportionally as you receive each installment, rather than all at once in the year of sale.
How it helps: By receiving payments over multiple years, each year’s gain is smaller, which might keep you in a lower tax bracket or at least defer part of the tax to future years. You effectively become the lender to the buyer, earning interest as well (interest income is taxable, but typically at ordinary rates). For instance, if you sell a property with a $500,000 gain via installments paid over five years, you might recognize roughly $100,000 of gain each year (plus interest), rather than $500,000 in one year. This can prevent a big one-time tax spike.
Caution: While installment sales defer the timing of tax, they do not eliminate tax; you’ll eventually pay the full amount of capital gains tax over the years. There’s also the risk of the buyer defaulting on payments, which could complicate things (you might get the property back through foreclosure, but that has its own tax implications). Not all sales are eligible for installment reporting (for example, sales of inventory or dealer property don’t qualify, and depreciation recapture on real estate over a certain amount cannot be deferred via installments — the portion taxed as ordinary income under depreciation recapture rules generally must be recognized in the year of sale). It’s crucial to use a solid contract and possibly secure the note with collateral. Many sellers use a third-party loan servicing agent to handle payments and paperwork.
4. Charitable Remainder Trust (CRT)
A Charitable Remainder Trust is a more advanced strategy that can completely avoid immediate capital gains tax while benefiting a charity and providing you income. Here’s how it works: You transfer your commercial property into a special irrevocable trust before selling it. The trust (being a tax-exempt entity) then sells the property. Because the trust is charitable in nature, it doesn’t pay capital gains tax on the sale. The sale proceeds stay in the trust, and you (and/or designated beneficiaries) receive an income stream from the trust for a term of years or for life (you negotiate a payout rate, say 5% annually). At the end of the trust’s term or your lifetime, the remaining assets in the trust go to a chosen charity.
Why use a CRT: You get a few key benefits: (1) No immediate capital gains tax on the sale, meaning the full sale proceeds (pre-tax) are invested in the trust, generating a larger income base for you. (2) You receive a partial charitable income tax deduction at the start, based on the calculated remainder that will go to charity. (3) You get an income stream for life or a set number of years (which can be a nice retirement plan). Essentially, a CRT lets you monetize an appreciated property without the tax hit, though eventually a charity gets the leftover principal.
Important trade-offs: This strategy is best for those who are charitably inclined to begin with. Once the property is in the trust, it’s irrevocable—you can’t take it back, and the portion destined for charity truly must go to a charitable organization at the end. The income you receive from the trust is taxable (a mix of ordinary income, capital gains, or tax-free return of principal depending on trust investments and IRS tier rules). Also, setting up a CRT requires legal work and fees, and the trust must adhere to IRS rules to retain its tax-exempt status. However, for highly appreciated commercial properties, a CRT can be a win-win: you avoid the upfront tax, secure an income, and contribute to a good cause.
Other Tax-Mitigating Moves to Consider
In addition to the major strategies above, there are a couple of other avenues to potentially avoid or reduce capital gains tax:
- Hold the property until death: If you don’t need to sell right now, one strategy is to keep the property until it becomes part of your estate. When you pass away, your heirs receive a step-up in basis to the property’s fair market value at that time. This means all the appreciation that happened during your lifetime would never be taxed as capital gain. Your heirs could sell the property immediately after inheriting and owe little or no capital gains tax. (Note: Estate taxes are a separate consideration for very large estates, but for capital gains purposes, the step-up is a powerful loophole. Just remember this means you don’t personally reap the sale profits during your life.)
- Convert to a primary residence (in limited cases): This is not typical for pure commercial properties, but if you have a mixed-use property or can actually move into the property, living there for at least two years might allow you to claim the Section 121 exclusion for a primary home sale. That exclusion lets you avoid tax on $250,000 of gain ($500,000 for a married couple) on the sale of a primary residence. For instance, if you have a duplex or a live/work building, and you make one unit your primary home for 2 out of the 5 years before sale, you might exclude a portion of the gain. Pure commercial buildings won’t qualify, but this can apply in edge cases or for those who convert a rental property to their home before selling.
- Refinance instead of sell: While not a sale strategy, remember that borrowing against the property (cash-out refinancing) is not a taxable event. Some investors pull out equity via loans and delay selling, or use refinancing to bridge to a 1031 exchange purchase. This way, they get liquidity without triggering taxes (just be mindful of debt and market risks).
Each of these alternatives has its own pros and cons, and may or may not be practical depending on your situation. Always consult with a tax advisor and plan ahead if you want to leverage these tactics.
Federal vs. State Capital Gains Taxes: Why Location Matters
Selling commercial property triggers federal capital gains tax, but state taxes can add another layer of cost depending on where you and the property are located. Here’s how location can affect your tax outcome:
Federal Capital Gains Tax Rules (Apply Everywhere)
At the federal level, long-term capital gains (assets held over a year) are taxed at 0%, 15%, or 20% rates, depending on your income. Most commercial property sellers fall into the 15% or 20% bracket for their gain. As discussed, depreciation recapture is taxed up to 25% federally. The 3.8% Net Investment Income Tax may also apply to high earners. These rules are uniform nationwide because it’s federal law. No matter where your property is, Uncle Sam will want his share of the gain unless you take steps to defer it (like a 1031 exchange or OZ investment).
It’s worth noting that if you successfully defer the gain through a 1031 exchange or similar, the federal tax is deferred as long as you hold the replacement property or investment. If you use a Charitable Remainder Trust, the federal tax is avoided on the sale entirely (because the trust is tax-exempt), although you may pay taxes on the income distributions you receive. In an installment sale, the IRS will tax each installment’s gain portion in whatever year you receive it.
State-Level Capital Gains Tax Nuances
States tax capital gains in different ways. Most states simply treat capital gains as regular income and tax it at the state’s income tax rates, but there are important differences. Let’s look at a few major states:
- California: No special capital gains rate; California taxes these profits as ordinary income (up to 13.3% for high earners) on top of federal tax. Residents owe California tax on gains wherever the property is, and non-residents also pay if the property sold is in California. The state did not adopt Opportunity Zone tax deferrals, so you still owe California tax on the gain even if it’s deferred federally. California follows 1031 exchange rules, but if you exchange a California property for one in another state, California will later “claw back” the deferred state tax when you sell without another exchange.
- New York: Taxes capital gains as regular income (up to ~8.8% for state, plus up to ~3.9% NYC tax if you’re a city resident). New York doesn’t provide a special lower rate for capital gains. The state follows federal deferral rules: 1031 exchanges are honored and Opportunity Zone deferral is allowed. Non-residents must file a NY return and pay tax on gains from New York property sales.
- Texas: No state income tax, so no state capital gains tax at all. A sale of property in Texas incurs zero state tax on the gain (only federal tax applies). If you live in Texas but sell a property located in another state that does have income tax (e.g., a Texas investor selling a building in California), that state will tax the gain because the real estate is in that state.
- Florida: Also has no state income tax, so Florida does not tax your capital gains. A Florida resident selling Florida property owes only federal tax. If a Florida resident sells property in another state, that state’s tax rules apply. Florida conforms to federal treatment for 1031 exchanges and similar deferrals.
- Other states: Many other states fall in between. For instance, states like Illinois and Pennsylvania have flat income tax rates (Illinois 4.95%, Pennsylvania ~3.07%) that would apply to capital gains. Some states like Arizona and Colorado have moderate income tax rates (4-5%). A few states provide limited exclusions or deductions for certain capital gains (for example, South Carolina allows a 44% exclusion on long-term capital gains, effectively taxing 56% of the gain at ordinary rates). Always check your specific state’s rules. The key point is to consider state taxes in your planning—sometimes doing a 1031 exchange can defer state tax as well, which can be a large savings if you’re in a high-tax state.
Common Mistakes to Avoid
When attempting to avoid or minimize capital gains tax on a commercial property sale, investors sometimes make costly mistakes. Here are some common pitfalls and how to avoid them:
- Missing 1031 deadlines or requirements: A very common error is failing to identify replacement property within 45 days or closing the purchase within 180 days in a 1031 exchange. These deadlines are strict. Mark them on your calendar and work closely with your Qualified Intermediary to stay on track. Additionally, choosing an ineligible replacement (e.g., a property of lesser value without using all proceeds) can result in taxable boot. Solution: plan your exchange well in advance, line up potential replacement properties early, and engage professionals who specialize in 1031 transactions.
- Touching the cash (disqualifying a 1031 exchange): If you receive the sale proceeds in your own bank account, even for a day, a 1031 exchange is blown—the IRS will tax the sale because you had constructive receipt of funds. Always use a Qualified Intermediary to handle the funds from the sale. Do not let the buyer pay you directly if you intend to exchange. Once the exchange is set up properly, resist any temptation to take out a portion of the money; any amount you take (or “boot”) will be taxable.
- Not planning for depreciation recapture: Some sellers are caught off guard by the extra tax due to depreciation recapture. They might calculate 15% or 20% on the gain but forget that the portion of gain from depreciation is taxed at 25%. This can result in underestimating the tax bill. Avoid this by working with a tax professional to estimate your tax exposure before selling. If you did a cost segregation or took bonus depreciation, be especially prepared for a larger recapture amount. Strategies like 1031 exchanges can defer recapture as well, since that gain is also deferred into the new property.
- Assuming any reinvestment avoids tax: Some people mistakenly believe that as long as they use the sale money to buy another asset (like another building, stocks, or a business), they won’t have to pay capital gains tax. This is false unless you use a specific provision of the tax code. Simply buying a new property after selling, outside of a 1031 exchange, does NOT shield you from tax. The sale is taxable; reinvesting the cash doesn’t matter to the IRS unless you follow the 1031 rules or invest in a qualified Opportunity Zone fund. Likewise, paying off business loans, buying equipment, or putting the money in stocks will not exempt you from the tax on the sale itself. Always execute the proper tax-deferred transaction procedure if you want the tax benefit.
- Not considering state taxes or the next sale: You might successfully defer taxes now, only to be surprised later. For example, if you do a 1031 exchange from a high-tax state property to a low-tax state property, remember that your original state (like CA) may track that gain. When you eventually sell without another exchange, you could get a tax bill from that original state. Also, Opportunity Zone deferrals will come due in 2026 – be prepared for that future tax payment. Think two steps ahead: if you plan to cash out in a few years, know the tax hit will eventually come unless you have another plan (or plan to hold until death for a step-up in basis).
- Failing to get professional advice: Real estate tax law is complex. One wrong move can nullify a tax break. For instance, an improperly structured installment sale or a small mistake in a 1031 paperwork could cost you big. Engaging a knowledgeable CPA or tax attorney when planning your sale is invaluable. They can help structure the deal correctly, ensure compliance with IRS rules, and advise you on the best strategy for your situation. The money spent on good advice can pale in comparison to the taxes saved or mistakes avoided.
By steering clear of these mistakes and planning carefully, you can execute your sale strategy with confidence and maximize the after-tax outcome.
Pros and Cons of Each Tax-Saving Strategy
The best method to avoid or defer capital gains tax depends on your goals and circumstances. Here’s a quick comparison of the major strategies and their advantages and disadvantages:
| Strategy | Pros | Cons |
|---|---|---|
| 1031 Exchange | – Defers 100% of taxes (gain & depreciation recapture) so you keep more money working for you. – Allows continual portfolio growth and flexibility to swap properties. – Well-established, with clear IRS rules and wide usage. | – Strict 45-day and 180-day deadlines to identify and close on new property. – Must reinvest full proceeds and equal or greater debt, limiting partial cash-out. – Requires finding suitable like-kind property quickly; can be challenging in hot markets. |
| Opportunity Zone | – Defers tax on original gain until 2026, offering a cash flow advantage now. – Potential to eliminate tax on the new investment’s appreciation after 10 years. – Encourages portfolio diversification into potentially high-growth projects. | – Only temporary deferral of the original gain (tax bill comes due by 2026). – Investment risk in OZ projects, which may be less proven or in weaker markets. – Less control: must invest via funds and comply with OZ rules; some states don’t honor the deferral. |
| Installment Sale | – Spreads tax payments over years, easing the immediate tax burden. – Can keep you in a lower tax bracket each year, potentially reducing effective tax rate. – You earn interest on the installment payments, adding to total proceeds. | – Risk of buyer default; you might have to foreclose or renegotiate. – You still pay full taxes eventually (plus ordinary income tax on interest). – Requires holding a note (illiquid) and handling loan administration or using a servicing agent. |
| Charitable Trust (CRT) | – Completely avoids upfront capital gains tax on the sale by using a tax-exempt trust. – Provides an immediate charitable tax deduction and steady income stream for you. – Fulfills philanthropic goals by benefiting a charity you choose. | – Irrevocable transfer: once done, you give up direct access to the principal asset. – The trust’s leftover value must go to charity, not your heirs (though other estate planning can complement this). – Setup costs and complexity; plus, the income you get is taxed according to IRS rules (not tax-free). |
Real-World Scenarios: Tax Savings in Action
Sometimes it’s easier to see how these strategies work through examples. Below are three scenarios comparing a standard taxable sale versus using a tax-saving method. Each scenario assumes a long-term capital gain and uses simplified numbers for illustration:
Scenario 1: Deferring a $500,000 Gain with a 1031 Exchange
Imagine you’re selling a commercial property with a $500,000 capital gain. If you simply sold and took the cash, you’d owe a significant tax on that gain immediately. Let’s compare outcomes:
| Regular Taxable Sale (no exchange) | 1031 Exchange (tax-deferred reinvestment) |
|---|---|
| Sells property for profit, realizes $500,000 gain. | Sells property and immediately reinvests all proceeds into a new like-kind property via 1031 exchange. |
| Pays federal capital gains tax (15% on $500k = $75,000) plus depreciation recapture and any state tax (say another $25,000 combined). Tax bill about $100,000. | Pays $0 tax now. All $500,000 of gain is deferred by moving into the new property. |
| Net after-tax proceeds around $400,000 to invest or spend. | Full $500,000 gain working for you in the new investment property (more equity to grow and potentially generate income). |
| No ongoing tax deferral—if you invest the $400k, you start anew with that amount. | Continues deferral: if you later sell the new property, you can do another 1031 or cash out and pay tax then. If you hold until death, the gain may be erased by step-up in basis. |
Result: The 1031 exchange lets you invest the entire $500k gain instead of losing $100k to taxes now. Your new property could be larger or higher value, increasing your potential returns. You do eventually owe taxes if you cash out later, but you control the timing (potentially indefinitely with continued exchanges).
Scenario 2: Reinvesting Gain into an Opportunity Zone Fund
Now suppose you sell a commercial building for a $200,000 gain. You want to defer the tax and also hope to eliminate some tax down the road, and you’re open to investing in a development project. Here’s the comparison:
| Regular Sale & Invest Elsewhere | Sale & Opportunity Zone Investment |
|---|---|
| Sells property, realizes $200,000 gain (long-term). | Sells property, realizes $200,000 gain, and invests the $200,000 gain into a Qualified Opportunity Fund within 180 days. |
| Pays federal capital gains tax in year of sale (approx. $30,000, assuming 15% + NIIT) and any state tax due. Net after-tax gain ~$170,000. | Pays $0 tax in year of sale on that gain (federal tax deferred). State tax is also deferred if the state conforms (if not, state tax might be ~$10,000 due). |
| Invests net proceeds in a standard investment (e.g. stocks or a non-OZ real estate project). No special tax benefits on future growth—future gains will be taxed. | The Opportunity Zone fund investment grows. Come tax year 2026, pays deferred tax on the original $200k gain (e.g. ~$30k federal). If the OZ investment is held 10+ years, any appreciation on that investment can be sold tax-free. |
| Example: The $170k investment grows to $250k over 10 years; selling it then triggers tax on $80k new gain (maybe ~$12k tax). Total after all taxes: about $408k (initial sale $170k + new profit $80k – taxes). | Example: The $200k OZ investment grows to $300k over 10 years. You sell the OZ investment and pay no tax on the $100k gain (since held 10 years). Total after all taxes: about $270k (initial sale gain $200k – $30k tax paid in 2026 + $100k tax-free profit). |
Result: The OZ route let you keep the full $200k working for an OZ project, and ultimately you got to keep the $100k growth from that project tax-free. The trade-off was tying up money for 10+ years in a specialized investment and still having to pay the original deferred tax in 2026. In contrast, the regular investment started with less (after immediate taxes) and its growth was fully taxable, resulting in a lower end balance despite potentially similar market performance.
Scenario 3: Using an Installment Sale for a $1 Million Property
Consider you have a small commercial building with a $300,000 gain (part of a $1 million sale). Instead of a cash sale, you agree to accept payments from the buyer over 5 years (with interest). How does that look?
| Cash Sale (All at Once) | Installment Sale (5-Year Payment Plan) |
|---|---|
| In year of sale, realizes $300,000 gain immediately. | In year of sale, maybe receives 20% down payment and a note for the rest. Let’s say $200,000 paid each year for 5 years (simplified). |
| Pays tax on entire $300k in one year (roughly $45,000 if 15% federal + some state). That tax must be paid from the proceeds, leaving less to invest or use. | Each year recognizes $60,000 of gain (1/5 of $300k) as income, paying perhaps ~$9,000 tax annually on the gain portion. Over 5 years, still pays ~$45,000 total, but spread out. |
| Net immediate cash after tax ~ $255,000 (plus the remaining sale proceeds which are principal return). Investor can invest what’s left after tax. | Also earns interest on the unpaid balance each year (taxed as interest income). For example, 5% interest could pay ~$40-50k total interest over 5 years, taxed at ordinary rates, but that’s extra income earned. |
| No more payments after sale – seller has all cash (after tax) upfront. | Buyer’s payments provide a steady income stream. Seller’s after-tax cash comes in gradually, possibly providing more total cash by end (principal + interest) than the lump sum scenario. |
| If seller was pushed into a higher tax bracket by the large one-year gain, they pay higher rates on part of it. | By spreading the gain, seller possibly stays in a moderate tax bracket each year, avoiding higher rate tiers. The tax bite feels smaller when broken up over time. |
Result: The installment sale doesn’t reduce the total tax due on the $300k gain (you eventually pay roughly the same $45k), but it defers and distributes the tax burden over five years. You also get interest income. This softens the impact—especially beneficial if the initial lump sum would bump you into a higher tax bracket or if you prefer a stream of income. The downside is the credit risk; you need the buyer to actually pay over time.
In all these scenarios, the tax-saving strategy provides a clear benefit either in the form of tax deferral or outright tax savings, helping you preserve capital. But each requires adherence to specific rules and often a long-term outlook.
Frequently Asked Questions (FAQ)
Can I legally avoid paying capital gains tax on a commercial property sale altogether?
Yes, by using IRS-sanctioned methods like a 1031 exchange, a Qualified Opportunity Zone investment, or a charitable trust, you can defer or potentially eliminate the capital gains tax legally.
Do I have to pay capital gains tax if I reinvest the proceeds into another property?
Yes, but only if you structure it as a 1031 exchange. Simply buying another property after the sale won’t exempt you—you must adhere to 1031 exchange rules to defer the tax.
Will moving to a state with no income tax save me from capital gains tax on my property sale?
No, moving your residence won’t avoid the federal capital gains tax. And if the property is in a high-tax state, that state will still tax the sale as source income, regardless of your residency.
If I move into my commercial property and live there for two years, can I avoid the capital gains tax?
Yes, if you convert it to your primary residence for 2 years, you can exclude up to $250k (single) or $500k (married) of the gain. Any remaining gain above that cap is still taxed.
Does a 1031 exchange mean I never have to pay taxes on the sale?
No, a 1031 exchange only defers the tax. You’ll owe it when you sell without another exchange, unless you keep exchanging until death—then the deferred gain disappears thanks to the basis step-up.
Can I use a 1031 exchange if I sell my business which includes real estate?
No. Only real estate qualifies for a 1031 exchange. The real property portion of a business sale could be structured to defer tax, but any gain from selling the business assets is taxable.
If I gift my commercial property to my children, do I avoid capital gains tax?
No, gifting avoids tax for you now, but your children get your cost basis. If they sell later, they’ll owe capital gains tax on the property’s appreciation.
Do Opportunity Zone investments eliminate my capital gains tax completely?
No, Opportunity Zones only defer your original capital gain until 2026, and while they can make new gains (on the OZ investment) tax-free after 10 years, you still have to pay the initially deferred tax.
Do I have to pay the 25% depreciation recapture tax separately from capital gains tax when I sell?
Yes, any depreciation you claimed on the property is taxed at a federal 25% rate upon sale (to the extent of gain). This recapture tax is in addition to the regular capital gains tax on the remaining gain.
Is it too late to avoid capital gains tax if I’ve already sold my property and received the money?
Yes, once the sale closes and you have the proceeds, it’s too late to set up a 1031 exchange or other deferral; tax planning must be done before closing.
Do older sellers or retirees get any special capital gains tax exemption for commercial real estate?
No, there are no age-based exemptions for capital gains on investment property—everyone pays the same tax rates regardless of age.
Will my heirs have to pay capital gains tax if they inherit my commercial property?
No. In general, your heirs get a stepped-up basis to the property’s value at your death, so they can sell it with little or no capital gains tax on the appreciation during your life.