A capital gain in commercial real estate arises when the proceeds of a property's disposition exceed its tax cost basis, called adjusted cost base in Canada and adjusted basis in the United States. The gain is not a single number: it is divided into two economically distinct components.
Depreciation recapture is the portion of the gain attributable to deductions previously taken against income; in the US this is ordinary income or taxed at special unrecaptured Section 1250 rates, and in Canada it is fully included in income as recaptured CCA under ITA s.13. The true capital gain is the remaining appreciation above original purchase price, and it is this portion that receives preferential tax treatment.
Blending these two components without distinguishing them is one of the most common errors in CRE exit analysis.
US sellers of business real property realize Section 1231 gains, named for the IRC provision that treats net long-term gains on depreciable business property as long-term capital gain, currently taxed at a maximum 20% federal rate for high-income taxpayers. Layered onto this is the 3.8% Net Investment Income Tax under IRC §1411, which applies to passive investment income for taxpayers above the $200,000/$250,000 MAGI thresholds, bringing the effective federal rate on capital gain to 23.8% for many institutional investors.
Unrecaptured Section 1250 gain (the straight-line depreciation taken on real property structures) is taxed at a maximum 25% federal rate under IRC §1(h)(1)(D), sitting between the LTCG rate and the 37% ordinary income rate. A 1031 like-kind exchange under IRC §1031 defers all recognized gain on the disposition by rolling equity into a replacement property of equal or greater value within strict timeline constraints.
In Canada, capital gains from commercial real estate dispositions are subject to the 50% inclusion rate under ITA s.38(a): one half of the gain is included in the taxpayer's income and taxed at their marginal rate; the other half is permanently tax-free. The principal residence exemption and the Lifetime Capital Gains Exemption, which shelters gains on qualified small business corporation shares, do not apply to income-producing commercial real estate.
Non-residents disposing of Canadian real property must obtain a Section 116 certificate from the CRA before or shortly after closing; without it, the buyer is required to withhold 25% of the gross proceeds and remit to the CRA, which can create serious liquidity issues at closing. Practitioners should confirm the current inclusion rate applicable to their client's entity type, as legislative changes may affect corporations and trusts differently than individuals.
Tax planning around CRE dispositions integrates directly into hold/sell analysis and should begin well before a sale is contemplated. In the US, Qualified Opportunity Zone investments under IRC §1400Z-2 offer temporary gain deferral and potential permanent exclusion on appreciation within the QOZ fund.
Conservation easement donations permitting a deduction equal to the appraised value of development rights conveyed have attracted intense IRS scrutiny as syndicated transactions; legitimate easements on genuinely valuable conservation land remain defensible. In Canada, Section 85 rollovers allow a taxpayer to transfer appreciated real property to a corporation at an elected amount below fair market value, deferring the gain recognition to a future disposition of the corporate shares.
Installment sale structures, which spread proceeds across multiple tax years, allow sellers in both jurisdictions to manage the rate bracket impact. All of these strategies must be modelled against the after-tax net proceeds of a clean taxable sale before they can be confirmed as genuinely advantageous.