Congrats on the exit. That's not all capital gain, though. Some of it is. A good chunk of it probably isn't, and the part that isn't can cost more than everything else combined.
Most operators carry one number into the sale of commercial real estate: the capital gains rate. They take the sale price, subtract what they paid, multiply by 20%, and call it the tax bill. That shortcut misses how the gain is actually built, how it's taxed, and what can offset it. Let's dig into it.
Why does taxable income come in different flavors?
Taxable activity is like ice cream. It comes in different flavors.
Ordinary income is vanilla. It's the default flavor, taxed at your progressive, marginal rates, and it tops out at 37%. Wages, interest, and business income all live here.
Capital gain is cookies and cream. Default-adjacent, with an added bonus: lower rates. Long-term capital gain rates generally cap at 20%.
And for the tax nerds, the net investment income tax is the rocky road on top. It adds 3.8% for individuals with modified adjusted gross income above $200,000, or $250,000 for married couples filing jointly. A passive investor with a large gain will usually pay it on most or all of that gain.
How is the sale of commercial real estate taxed?
When you sell CRE, the gain typically breaks down into three flavors.
The first is Section 1245 recapture: depreciation recapture on personal property. In a real estate deal, that's the short-life components a cost segregation study carved out of the building, and in practice it's largely your bonus depreciation coming home. It can be as large as the bonus taken on those components, depending on how the sale price is allocated among the property's assets. It's taxed at ordinary rates, up to 37%. Land improvements like parking lots are technically real property with their own recapture rules, but the portion of their bonus and accelerated depreciation above straight-line generally comes back at ordinary rates too.
The second is unrecaptured Section 1250 gain: the straight-line depreciation you took on the building itself. It's taxed at a maximum federal rate of 25%.
The third is Section 1231 gain: the appreciation above your original cost, the part that reflects the property actually going up in value. It's taxed at long-term capital gain rates, capped at 20%.
Plain English: every dollar of depreciation you took during the hold lowered your basis, and at sale it comes back as gain at a rate that depends on how you took it. The only piece that gets the rate most people have in their heads is the true appreciation. For more on why the first two flavors exist at all, see Depreciation Is a Loan Against Your Future Gain. For how the size of each slice gets locked in years before the sale, see Your Exit Gain Gets Taxed in Three Buckets.
What's the tax on a $13 million commercial property sale?
Take a multifamily property bought for $10 million, with $1.5 million allocated to land. A cost segregation study carves $2 million into short-life components, all taken as bonus depreciation in year one. The remaining $6.5 million of building depreciates over 27.5 years, which adds up to about $1.4 million over a six-year hold.
Total depreciation is $3.4 million, so the adjusted basis is $6.6 million. The property sells for $13 million. Ignoring closing costs, that's a $6.4 million gain.
For illustration, assume the full $2 million of bonus comes back as ordinary recapture. The flavors then look like this: $2 million of ordinary income, $1.4 million of unrecaptured 1250 gain, and $3 million of 1231 gain.
At the top federal rates, that's $740,000 on the ordinary slice, $350,000 on the 1250 slice, and $600,000 on the 1231 slice. Add about $243,000 of net investment income tax and the federal bill lands around $1.93 million. The back-of-the-envelope version, $6.4 million times 20%, says $1.28 million. That's a $650,000 miss before a single dollar of state tax.
Your numbers will differ. Your actual bracket, the way the sale price gets allocated across the property's assets, and your state all move the result. The pattern holds, though: the more aggressively you depreciated, the more of your gain shows up as vanilla. That's the trade for the deductions you enjoyed during the hold, and it's often a good one. It just needs to be in the model.
Why isn't the gain the same as the cash?
Understanding tax exposure on a disposition is never as simple as cash in minus cash out. Tax gain is the amount realized minus your adjusted basis, and the amount realized includes the debt that gets paid off at closing.
Say that same property carries a $7 million loan. The sale produces about $6 million of cash before closing costs, and $6.4 million of taxable gain. If you pulled equity out with a cash-out refinance during the hold, the gap can be much wider. Owners can owe tax on a gain larger than the check they receive. I wrote about exactly how that happens in A Cash-Out Refinance Pays You Tax-Free Because of Basis.
What can offset the gain?
The biggest item most people forget is suspended passive losses. If you've been allocated passive losses from this property that you couldn't use during the hold, a fully taxable sale of the entire property, or of your entire interest, to an unrelated buyer releases them. Once released, they can offset any kind of income, including the ordinary recapture. For an LP who spent years watching bonus depreciation sit unused on their K-1, this can dramatically change the actual tax exposure on the sale. The full story is in Suspended Passive Losses Are a Vault Waiting on the Exit.
Two items can push the other direction. If you had net Section 1231 losses in any of the prior five years, part of this year's 1231 gain can be recharacterized as ordinary income. And most states tax gains at their regular income tax rates, with the state where the property sits often taxing nonresident owners on their share.
How can you reduce tax on the sale of commercial property?
The time to understand the flavors is before the purchase agreement is final, while you still have options.
A properly structured 1031 exchange can defer the 1231 gain, the unrecaptured 1250 gain, and often much of the recapture, though recapture on components that count as personal property can still be taxed. An installment sale can spread the gain over several years, with one catch that surprises people: the ordinary-rate recapture is recognized in the year of sale no matter how the payments are structured. The lazy 1031 pairs a passive gain with a fresh first-year passive loss from a new investment. And sometimes the best move is simple timing: landing the sale in a year when suspended losses or lower income soften the blow.
In a syndication, there's one more layer. Every partner's exposure is different. The waterfall and promote shift gain between the GP and the LPs, contributed property can carry its own built-in gain, each partner has a different suspended loss balance, and each one lives in a different state and bracket. A single deal-level estimate won't tell any individual partner what they'll owe. For the complete framework, start with the exit structuring guide.
Cash in minus cash out tells you what the deal made. The flavors tell you what you keep.
This is general education, not tax advice. Depreciation recapture, gain character, the net investment income tax, and passive loss release are fact-specific and depend on how the property was depreciated, how the sale is allocated, and each owner's full tax picture. The figures above are illustrative, at top federal rates, and exclude state tax. Review any sale with your CPA before you sign.