Selling the Building Your Business Owns: What Gets Taxed
How gain on business real estate splits into ordinary recapture, 25 percent unrecaptured gain, and capital gain, and the choices that defer or spread it.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
Gain on business real estate is taxed in layers: gain from building depreciation is taxed at up to 25 percent, depreciation on components reclassified as personal property is recaptured as ordinary income, and the rest is long-term capital gain. A 1031 exchange can defer all of it; an installment sale spreads the gain but not the ordinary-income recapture.
On this page
How does the gain break down?
| Layer | What it is | Rate |
|---|---|---|
| Section 1245 recapture | Depreciation on components a cost segregation study reclassified as personal property (carpet, removable fixtures, equipment), including any Section 179 or bonus claimed on them | Ordinary income |
| Unrecaptured Section 1250 gain | Straight-line depreciation claimed on the building and other real property such as land improvements (bonus or accelerated depreciation on land improvements beyond straight-line is ordinary recapture under Section 1250) | Maximum 25 percent |
| Remaining gain | Appreciation above original cost, plus gain on land | Long-term capital gain (0, 15, or 20 percent) |
| Net investment income tax | Applies to the gain if the real estate activity was passive to you (gain treated as nonpassive under the self-rental or grouping rules is excluded) and modified adjusted gross income exceeds $200,000 ($250,000 married filing jointly; not indexed) | Additional 3.8 percent |
A net Section 1231 loss for the year is fully ordinary, which is why the netting rules matter: a net Section 1231 gain is treated as long-term capital gain, but it is recharacterized as ordinary to the extent of net Section 1231 losses from the five preceding tax years that have not already been recaptured (Section 1231(c)).
Does the structure matter?
- Building in a separate LLC rented to the operating company. If the LLC is disregarded, the sale is reported by its owner; the self-rental rule (and any grouping of the rental with the business) decides whether the gain is passive, and the buyer either takes over the lease or the operating company must move.
- Building inside a C corporation. Gain is taxed at 21 percent in the corporation and again when distributed — the main reason to keep real estate out of C corporations.
- Building inside an S corporation. Gain passes through once, but distributing the building rather than selling it is a deemed sale at fair value.
- Sold with the business. The purchase price allocation puts a value on the real estate (Class V), and the buyer's depreciation starts from that figure.
What defers or spreads the tax?
- 1031 exchange into other real property defers the gain, including recapture, if all proceeds are reinvested and no cash or other boot is received — though Section 1245 recapture on cost-segregated components can still be triggered if the replacement property carries less Section 1245 property (Section 1245(b)(4)). The deadlines are 45 days to identify and 180 days to close (or the return due date, with extensions, if earlier).
- Installment sale spreads the capital gain and the 25 percent gain over the payments (the 25 percent gain is reported first), but all ordinary-income recapture — Section 1245, plus any Section 1250 depreciation beyond straight-line — is taxed in the year of sale regardless of cash received (Section 453(i)).
- Opportunity zone investment of the capital gain in a qualified opportunity fund within 180 days defers it, but gain invested before 2027 must be recognized by December 31, 2026, so a 2026 sale gets little deferral. P.L. 119-21 made the program permanent: amounts invested after 2026 defer the gain for five years (with a 10 percent basis increase after five years, 30 percent for rural funds), and new rolling 10-year zone designations begin in 2027.
- Holding until death gives heirs a basis stepped up to fair market value, eliminating the built-in gain, including gain deferred by earlier 1031 exchanges (but not gain still deferred under an installment sale, which remains taxable to the heirs as income in respect of a decedent).
What records are needed at sale?
The original closing statement, the depreciation schedule from the first year, every improvement capitalized, cost segregation reports, and the allocation between land and building. Missing records inflate taxable gain because basis cannot be proven.
Frequently asked questions
Can I avoid recapture by not claiming depreciation?
No. Recapture and basis reduction are based on depreciation allowed or allowable, so skipping it only loses the deduction; missed depreciation can usually be claimed by filing Form 3115 to change the accounting method.
Is the gain subject to self-employment tax?
No. Gain on selling business real estate is excluded from self-employment income unless the property is inventory or held for sale to customers, as with a dealer (Section 1402(a)(3)).
Does Florida tax the gain?
Florida has no personal income tax; a C corporation pays Florida corporate income tax on it. Documentary stamp tax applies to the deed.
Can I sell the building and lease it back?
Yes. A sale-leaseback converts equity into cash and the rent is deductible, but the sale is fully taxable, and the arrangement must be at fair rent.
Official sources
The IRS explains: “If you have a net section 1231 gain, it is ordinary income up to the amount of your nonrecaptured section 1231 losses from previous years. The rest, if any, is long-term capital gain.” — Internal Revenue Service, Publication 544 (2025), Sales and Other Dispositions of Assets, https://www.irs.gov/publications/p544
The IRS explains: “Use Form 4797 to report: The sale or exchange of property. The involuntary conversion of property and capital assets. The disposition of noncapital assets.” — Internal Revenue Service, About Form 4797, Sales of Business Property, https://www.irs.gov/forms-pubs/about-form-4797
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk calculates each layer of gain before a listing agreement is signed. See pricing or book a free fit call.
Cross-border taxes, handled in one place
U.S. and Canadian filings prepared together by our U.S. and Canadian Tax Desks.
Book a free fit call