Capital gains are the profits earned from the sale of a capital asset, including stocks, bonds, real estate, or other investments. You can calculate the capital gain 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 taxable income, meaning you must report it 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. 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 held as an investment. You can calculate the capital gain by subtracting the adjusted basis of the property from the sales price.
The adjusted basis takes into account any improvements or depreciations on the property over the holding period. Adjust the basis upwards by the cost of any improvements made to the property, and downwards by any depreciation taken.
For example, say an investor purchases a commercial property for $1 million. If they make $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 comes out to $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. This rate ranges from 0% to 20% depending on the investor’s income level and the length of time they held the property. Certain tax deductions and strategies may minimize the 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 a capital asset to the government, and therefore collects a tax on the profits of the sale of the asset.
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 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.
1031 Exchange
A 1031 exchange, also known as a like-kind exchange or a Starker exchange, is a tax-deferred transaction in the United States. It 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.
A 1031 exchange defers the capital gains taxes normally owed on the sale of the property until the sale of the new property. Potentially, an investor can 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.
The rules surrounding 1031 exchanges can be complex and require careful planning and execution to ensure compliance with IRS regulations. Therefore, it is best for investors to 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 when it’s time to sell, everything you need is 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.
