To calculate the tax on the sale of commercial property, you work through the profit in layers: find your adjusted basis, subtract it from the net sale price to get your total gain, then tax the portion tied to past depreciation at up to 25% and the rest at long-term capital gains rates of 0%, 15%, or 20%. High earners add a 3.8% surtax on top. State tax comes on after that. Skip a step and you either overpay or file a return the IRS will fix for you.
Step 1: Find Your Adjusted Basis
Adjusted basis is what the IRS treats as your real investment in the property. It’s the number you subtract from the sale proceeds to arrive at your taxable gain, so every dollar you can legitimately add reduces your tax.
Start with the original cost basis: the purchase price plus acquisition costs paid at closing, such as legal fees, recording fees, and transfer taxes.1Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property-Cost Your original settlement statement will show these.
Add the cost of capital improvements you made during ownership. A capital improvement adds value, extends useful life, or adapts the building to a new use: a new roof, a new elevator, an added parking structure. Ordinary repairs like patching drywall or fixing a faucet don’t count here because you already deducted them in the year they occurred.2Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
Subtract the total depreciation that was allowable over your entire holding period. This one catches sellers: even if you never actually claimed depreciation on your returns, the IRS reduces your basis by the amount you could have claimed.3Office of the Law Revision Counsel. 26 USC 1011 – Adjusted Basis for Determining Gain or Loss Nonresidential real property depreciates on the straight-line method over 39 years.4Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
The formula is simple: purchase price, plus improvements, minus allowable depreciation, equals adjusted basis.
Splitting the Purchase Price Between Land and Building
Only the building depreciates. Land doesn’t wear out. If you bought both together for a lump sum, split the price using the fair market value of each at the time of purchase. If the land was worth $300,000 and the building was worth $700,000, 70% of the purchase price is allocated to the building.5Internal Revenue Service. Basis of Assets (Publication 551) Assessed values from the property tax bill work as a backup when you don’t have reliable market values.
If You Inherited the Property
Inherited property gets a different starting point. Your basis is the property’s fair market value on the date the previous owner died, not what they originally paid.6Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired from a Decedent That stepped-up basis often wipes out decades of appreciation from the taxable gain. You still subtract any depreciation you personally claimed or could have claimed after inheriting.
Step 2: Calculate the Net Amount Realized
The net amount realized is what you actually walked away with, economically speaking. Start with the gross sales price. Then subtract every cost you paid to make the sale happen.
Brokerage commissions are usually the biggest, commonly 2% to 6% on commercial deals. On a $2,000,000 sale at 4%, that’s $80,000 off the top. Add legal fees for the closing, advertising, title insurance premiums you paid as seller, and any transfer taxes you owed. These aren’t separate deductions on your return; they reduce the sale proceeds directly, and every dollar of reduction cuts a dollar of taxable gain.
One wrinkle: if the buyer paid property taxes that covered your ownership period, the IRS treats that as additional sale proceeds. Add it back to the gross price before subtracting selling costs.
Your total gain is the net amount realized minus your adjusted basis.
Step 3: Tax the Depreciation Recapture Portion First
Before the favorable capital gains rates apply, the IRS claws back part of the benefit you got from depreciation deductions. The portion of your gain equal to the total depreciation taken or allowable on the building is called “unrecaptured Section 1250 gain,” and it’s taxed at up to 25%.7Office of the Law Revision Counsel. 26 USC 1(h) – Tax Imposed
In practice: if you claimed $200,000 in depreciation over ten years, that $200,000 slice of your profit is taxed at up to 25%, which is up to $50,000. Only the gain above that $200,000 moves on to capital gains rates. This is why the depreciation figure from Step 1 matters so much; it sets how much of the gain falls into the higher-rate bucket.
Personal Property Sold with the Building
Equipment, fixtures, and other personal property that isn’t a structural component of the building fall under a harsher rule. Depreciation recaptured on personal property is taxed at your ordinary income rate, with no 25% cap.8Office of the Law Revision Counsel. 26 US Code 1245 – Gain from Dispositions of Certain Depreciable Property Removable shelving, specialized manufacturing equipment, non-structural improvements. How the purchase agreement allocates the sale price between the building and personal property can shift your total bill noticeably, so it’s worth negotiating carefully.
Step 4: Apply Capital Gains Rates to the Rest
The gain left after depreciation recapture is a long-term capital gain, assuming you held the property more than one year.9Office of the Law Revision Counsel. 26 USC 1222 – Other Terms Relating to Capital Gains and Losses More precisely, it’s Section 1231 gain, which gets capital gains treatment when it exceeds your Section 1231 losses for the year.10Office of the Law Revision Counsel. 26 US Code 1231 – Property Used in the Trade or Business and Involuntary Conversions
For 2026, the long-term capital gains rates and income thresholds are:11Internal Revenue Service. Revenue Procedure 2025-32
- 0% on taxable income up to $49,450 single or $98,900 married filing jointly.
- 15% on taxable income above those amounts up to $545,500 single or $613,700 married filing jointly.
- 20% on taxable income above $545,500 single or $613,700 married filing jointly.
Most commercial sellers land in the 15% or 20% bracket because the gain from the sale, stacked on top of their other income, pushes them well past the lower thresholds.
The Five-Year Lookback
If you had net Section 1231 losses in the previous five years that reduced your ordinary income, the IRS recharacterizes your current Section 1231 gain as ordinary income up to the amount of those prior losses.12Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets You already got the ordinary-rate benefit from the losses, so you don’t get capital gains rates on an equal amount now. Only the gain above the unrecaptured prior losses qualifies for the lower rates.
Suspended Passive Losses Free Up
If the property was a passive activity for you and you carried suspended passive losses you couldn’t deduct in earlier years, selling the whole interest in a fully taxable transaction unlocks them. All previously disallowed passive losses become deductible and can offset the gain from the sale.13Office of the Law Revision Counsel. 26 US Code 469 – Passive Activity Losses and Credits Limited You’ll report them on Form 8582 in the year of sale.
Step 5: Add the 3.8% Net Investment Income Tax if It Applies
Higher earners owe an extra 3.8% surtax on net investment income, and gains from commercial property sales count. The tax kicks in when your modified adjusted gross income exceeds $200,000 single or $250,000 married filing jointly.14Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Those thresholds don’t adjust for inflation, so they reach more taxpayers each year. When it applies, a top-bracket seller faces up to 23.8% on the capital gain portion and up to 28.8% on the depreciation recapture portion.
State Taxes
Federal is only part of it. Most states tax capital gains as ordinary income, and rates run from zero in no-income-tax states to over 13% in the highest-tax states. Some states carve out reductions for certain gains, but commercial property is rarely on that list. State or local transfer taxes at closing add further cost and vary widely by jurisdiction. In a high-tax state, the combined federal-and-state rate on the capital gain portion can approach 40%.
Worked Example
Say you bought a commercial building for $1,500,000, spent $100,000 on capital improvements, and claimed $300,000 of depreciation over the years. Your adjusted basis is $1,300,000.
You sell for $2,000,000 and pay $100,000 in selling costs. Net amount realized: $1,900,000. Total gain: $600,000.
The first $300,000 (the depreciation piece) is taxed at up to 25%, so up to $75,000 in recapture tax. The remaining $300,000 is taxed at your capital gains rate. At 20%, that’s $60,000. If the 3.8% net investment income tax applies to both slices, add roughly $22,800. The federal bill lands around $157,800 before state tax.
Every input matters. A capital improvement you forgot to add, or a depreciation figure that’s off, can move the final number by thousands of dollars.
Where You Report It
Commercial property sales go on Form 4797, Sales of Business Property. A gain flows through Part III (Section 1250 depreciation recapture) and Part II (remaining gain).15Internal Revenue Service. Instructions for Form 4797 – Sales of Business Property Land and building are reported separately, since only the building is depreciable.
If you used the installment method, add Form 6252 in the sale year and every subsequent year until the final payment, even in years you receive nothing. Suspended passive losses go on Form 8582. Everything ultimately flows to Schedule D and Form 1040.
Ways to Defer the Tax
Two options change the calculation above and are worth mentioning because they can move the entire number.
A Section 1031 like-kind exchange defers all capital gains and depreciation recapture tax if you reinvest the proceeds into another qualifying real property held for business or investment use.16Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment You get 45 days from closing to identify replacement property in writing and 180 days to close on it, and the proceeds must go to a qualified intermediary rather than to you. Property held primarily for sale to customers, like a developer’s inventory, doesn’t qualify. Missing either deadline by a day kills the exchange and makes the full gain taxable.
An installment sale spreads the gain over the years you receive payments, with each payment split into return of basis, gain, and interest.17Office of the Law Revision Counsel. 26 US Code 453 – Installment Method One catch: depreciation recapture cannot be spread. The entire recapture amount is taxable in the year of sale, whether or not you’ve received the cash to cover it.18Internal Revenue Service. Publication 537 (2025), Installment Sales If you claimed $200,000 in depreciation, that $200,000 hits your return in full the year you sell. Plan for the cash flow mismatch before you sign the note.