Capital gains refer to the profits earned from the sale of a capital asset, such as stocks, bonds, real estate, or other investments. The capital gain is calculated by subtracting the cost of the asset (known as the “basis”) from the sales price. Let’s dive deeper into capital gains, specifically for commercial real estate.
The low-down on capital gains
For example, if you purchased a stock for $1,000 and sold it for $1,500, your capital gain would be $500. This gain is considered taxable income and must be reported on your income tax return.
Capital gains are typically subject to different tax rates than ordinary income, depending on the holding period of the asset. Assets held for more than a year are generally subject to lower tax rates than assets held for a shorter period of time. The tax rate on long-term capital gains varies depending on your income level and can range from 0% to 20%.
Commercial Real Estate Capital Gains
In commercial real estate, capital gains refer to the profits earned from the sale of a property that was held as an investment. The capital gain is calculated by subtracting the adjusted basis of the property from the sales price.
The adjusted basis takes into account any improvements made to the property over the holding period, as well as any depreciation taken on the property. The basis is typically adjusted upwards by the cost of any improvements made to the property, and downwards by any depreciation taken.
For example, if an investor purchases a commercial property for $1 million, makes $200,000 in improvements to the property, and sells it for $1.5 million after holding it for 5 years, the investor’s capital gain would be $300,000 ($1.5 million sales price – $1.2 million adjusted basis).
Capital gains on commercial real estate investments are subject to taxation at the long-term capital gains tax rate, which can range from 0% to 20% depending on the investor’s income level and the length of time the property was held. Additionally, certain tax deductions and strategies may be used to minimize the amount of capital gains tax owed on the sale of a commercial property.
Types of Capital Gains Taxes
Short vs. Long Term Capital Gains Taxes
Commercial real estate is considered a capital asset to the government, and therefore collects a tax on the profits of the sale of the asset when the time comes.
Short Term: For assets held less than a year, the gain is classified as short term and is taxed as ordinary income. In this scenario, investors will expect to pay taxes at the rate of their normal income bracket.
Long Term: For assets held more than a year, the gain is classified as long term and as is taxed accordingly. Typically, the long term rate is less than the ordinary income, and is solely dependent upon the taxpayer’s income and filing status.
A 1031 exchange, also known as a like-kind exchange or a Starker exchange, is a tax-deferred transaction in the United States that allows an investor to sell a real estate property and then reinvest the proceeds in another property of equal or greater value, without paying capital gains taxes on the sale.
In a 1031 exchange, the capital gains taxes that would normally be owed on the sale of the property are deferred until the new property is sold, potentially allowing the investor to defer taxes indefinitely if they continue to reinvest in like-kind properties. This can be a powerful tool for real estate investors looking to grow their portfolios while minimizing tax liabilities.
It’s important to note that the rules surrounding 1031 exchanges can be complex and require careful planning and execution to ensure compliance with IRS regulations. Therefore, it’s recommended that investors consult with a qualified tax professional or financial advisor before pursuing a 1031 exchange.
How STRATAFOLIO Helps
STRATAFOLIO organizes your documents for each property so that when it comes time to sell, you have everything you need in one place. Additionally, you can “sell” a property in STRATAFOLIO, which will show you analytics surrounding acquisitions, along with the value of the property. Contact us today to speak with an expert.