Selling Business Real Estate: Capital Gains, Depreciation Recapture, and 1031 Exchange

Selling business real estate triggers a two-layer tax: depreciation recapture (the gain attributable to previously claimed depreciation, taxed at 25% as “unrecaptured Section 1250 gain”) and capital gain on any appreciation above the original cost (taxed at 0%, 15%, or 20% depending on income). The 1031 like-kind exchange under IRC 1031 allows the seller to defer BOTH layers of tax by reinvesting the net proceeds into replacement real property of equal or greater value. The TCJA (2018) limited 1031 exchanges to real property only; exchanges of equipment, vehicles, machinery, and other personal property are no longer permitted. The exchange must follow strict timelines: the replacement property must be identified within 45 days and acquired within 180 days of the sale. All proceeds must be held by a qualified intermediary (the seller can’t touch the funds).

How does the tax work when selling a business property?

What types of property don’t qualify for a 1031 exchange?

Since the Tax Cuts and Jobs Act of 2017, only real property qualifies for like-kind exchange treatment. Personal property (equipment, vehicles, machinery, aircraft, artwork) no longer qualifies. Within real property, inventory, property held primarily for sale (dealer property), stocks, bonds, partnership interests, and certificates of trust do not qualify. Your primary residence and vacation homes don’t qualify unless they meet the strict rental-use requirements. Foreign real property and domestic real property are not considered like-kind to each other, so you cannot exchange a U.S. building for a foreign one.

Can I offset capital gains with capital losses from other investments?

Yes. Capital losses first offset capital gains of the same type (short-term losses against short-term gains, long-term against long-term), then any remaining net loss offsets gains of the other type. If net capital losses exceed capital gains, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately). Unused losses carry forward indefinitely to future tax years, maintaining their character (short-term or long-term). The wash sale rule (IRC 1091) prevents you from claiming a loss if you repurchase substantially identical securities within 30 days before or after the sale. Tax-loss harvesting before year-end is a common strategy to realize losses that offset gains elsewhere in the portfolio.

Related guides:

• Selling Rental Property: Depreciation Recapture, Capital Gains, and 1031 Exch…
• Depreciation Recapture: What Happens When You Sell Business Assets (Sections …
• Tax Consequences of Selling Your Small Business

Does selling a rented commercial building free old losses?

Yes, if you sell your entire interest in the activity to an unrelated buyer in a fully taxable sale. Suspended passive losses from the building first offset passive income from your other activities that year, and whatever’s left is treated as non-passive, so it can offset other income.

A 1031 exchange works differently. It generally doesn’t free suspended losses, because the gain isn’t fully recognized, so the losses keep carrying forward. That’s worth weighing against the $128,039 the exchange defers in the example above.

A large release can still be trimmed. The excess business loss limit applies after the passive rules, at $313,000 ($626,000 joint) for 2025 and $256,000 ($512,000 joint) for 2026, and the limit is now permanent. Any excess becomes a net operating loss carryover. And a sale to a related party doesn’t free the losses at all until that party sells to someone unrelated.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.