Selling Smart

Mitigating Depreciation Recapture and Capital Gains on Commercial Real Estate

Selling commercial real estate can be a lucrative venture, but tax implications can eat into your profits. Depreciation recapture and capital gains taxes are significant concerns for sellers. However, there are strategies you can employ to minimize their impact.

Understanding the Tax Triggers:

• Depreciation Recapture: When you claim depreciation deductions for a property on your tax returns, you essentially reduce its taxable basis (original cost minus depreciation). Upon selling, if the sale price exceeds the adjusted basis, the difference is treated as depreciation recapture and taxed at a 25% rate.
• Capital Gains Tax: The difference between the sale price and the adjusted basis, minus any depreciation recapture, is considered capital gain. Capital gains are generally taxed at lower rates than ordinary income, but they can still add a significant tax burden.

Strategies to Mitigate the Tax Bite:

1. 1031 Exchange: This powerful strategy allows you to defer capital gains and depreciation recapture by reinvesting the sale proceeds into a “like-kind” property (similar type) within a specific timeframe and following strict IRS guidelines. This essentially allows you to grow your commercial portfolio without immediate tax consequences.
2. Hold Until Death: While not a practical solution for everyone, inheriting property often eliminates capital gains taxes for heirs. The property’s basis is stepped up to its fair market value at the date of death, potentially eliminating any capital gains tax liability.
3. Maximize Deductions: Throughout ownership, meticulously track and claim all allowable deductions associated with the property, such as repairs, maintenance, and property taxes. These deductions lower your taxable income and reduce the overall capital gains upon sale.
4. Tax-Loss Harvesting: If you have other investment holdings with unrealized losses, consider selling them in the same year you sell your commercial property. These losses can offset capital gains from the sale, reducing your overall tax liability.
5. Consult a Tax Professional: Tax laws are complex, and the best strategy for you will depend on your specific circumstances. Consulting a qualified tax advisor experienced in commercial real estate transactions is crucial. They can help you navigate the tax code, identify the most beneficial approach, and ensure compliance with IRS regulations.

Additional Considerations for Commercial Sellers:

• Cost Segregation Studies: These studies can help identify and separate short-lived building components from the overall property, allowing for faster depreciation deductions and potentially reducing future depreciation recapture.
• Like-Kind Property Definition: Understanding the nuances of “like-kind” properties is essential for a successful 1031 exchange. Consult with your tax advisor to ensure the replacement property qualifies.

By implementing these strategies and seeking professional tax advice, commercial real estate sellers can significantly mitigate the impact of depreciation recapture and capital gains taxes. Remember, tax laws can change, so staying up-to-date and consulting with a qualified professional is key to maximizing your after-tax profits.