Investing in commercial real estate can be a lucrative venture, but it’s important to understand the tax implications associated with this type of investment. One tax that may apply is the capital gains tax, which can have a significant impact on your bottom line. Let’s take a closer look at capital gains tax and how it applies to commercial real estate.
What is Capital Gains Tax?
Capital gains tax is a tax on the profit made from the sale of an asset that has increased in value. This tax applies to a wide range of assets, including stocks, bonds, and real estate. When you sell an asset for more than you paid for it, the difference between the purchase price and the sale price is considered a capital gain.
For example, if you purchased a piece of commercial real estate for $500,000 and sold it five years later for $750,000, you would have a capital gain of $250,000. This gain is subject to capital gains tax.
How is Capital Gains Tax Calculated?
The amount of capital gains tax you’ll owe depends on a few factors, including your income and how long you held the asset. If you held the asset for more than a year, it’s considered a long-term capital gain and is subject to lower tax rates than short-term capital gains.
The tax rates for long-term capital gains range from 0% to 20%, depending on your income. If your income is below a certain threshold, you may not owe any capital gains tax at all. Short-term capital gains are taxed at your ordinary income tax rate.
In addition to federal capital gains tax, you may also owe state capital gains tax, which varies depending on where you live.
How Does Capital Gains Tax Apply to Commercial Real Estate?
When you sell commercial real estate for a profit, the capital gain is subject to capital gains tax. However, there are a few ways you can reduce or defer the amount of tax you owe.
One option is to use a 1031 exchange, which allows you to defer paying capital gains tax if you reinvest the proceeds from the sale into a similar property. To qualify for a 1031 exchange, the new property must be of equal or greater value than the property you sold, and you must follow a strict set of rules and timeframes.
Another option is to use a Qualified Opportunity Fund (QOF), which was created as part of the 2017 Tax Cuts and Jobs Act. QOFs allow you to defer paying capital gains tax by investing in designated low-income communities. If you hold the investment for at least 10 years, you may be able to eliminate the capital gains tax on the new investment altogether.
Commercial Real Estate Management is Stress-Free with MKS&H
Capital gains tax is an important consideration for anyone investing in commercial real estate. By understanding how this tax works and exploring strategies for reducing or deferring it, you can maximize your profits and minimize your tax liability. Working with a tax professional like the accountants at MKS&H can help you navigate this complex area of investing and make informed decisions that align with your goals and financial situation.
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture and your business goals. This approach enables our clients to achieve their greatest potential.