Disclaimer: I am not an attorney and this article is not intended as a substitute for advice from the appropriate legal, zoning, financial, construction and/or tax professionals. This information is provided for educational purposes only and is made without warranties or representations

The biggest expense for most commercial property owners is property taxes, and it’s also one of the most widely discussed forms of tax in commercial real estate. However, there are other kinds of taxes associated with CRE. For example, when you sell a piece of your portfolio, there’s a reasonable expectation that you’ll pay some kind of taxes on that transaction, right? So, what are those taxes in the state of California in 2023?

First, a Disclaimer: I’m not an accountant. I’m a real estate broker specializing in California commercial real estate. That means, while I’m here to help get you the best possible sale price on commercial real estate you’ve decided to sell, my dealings end when the paperwork is signed. I don’t handle your tax liabilities or anything else related to the sale. I strongly recommend talking to a specialized accountant with experience in commercial real estate taxes to verify any information and answer any questions you may have.

Is There a Sales Tax on Commercial Real Estate in California in 2023?

Forgive the specific subheading; truthfully, many of those factors aren’t relevant. A better question would be, is there a sales tax on commercial real estate at all?

Generally, the answer is no. However, that’s not to say that you won’t pay taxes on commercial real estate when you sell. Rather, simply that the tax you pay isn’t a sales tax; it’s the capital gains tax. This is because commercial real estate is considered an investment, and when any investment is sold, the profits from that sale are considered gains in capital, or capital gains.

Three Tiers of Taxes in California

In California, there are up to three tiers of taxes you may have to pay on the sale of a piece of commercial real estate.

The three tiers are:

• Federal Capital Gains Taxes, which apply to anyone selling property under United States jurisdiction.
• State Capital Gains Taxes, which in California are just part of income tax.
• Local/City-Level Capital Gains Taxes, which in California vary from 0% to 5.5% depending on where you are.

All of this ends up more complex than you would want as an investor, so it’s no wonder that there are thousands of tax specialists throughout the state who do nothing but commercial real estate tax preparation.

Federal Capital Gains Taxes on Commercial Real Estate Sales

Federal capital gains taxes can be complex on their own. You first have to determine whether your capital gains are considered short-term or long-term.

“Short-term capital gains are generally defined as gains on assets held for less than one year, while long-term capital gains are generally defined as gains on assets held for more than one year. Both types of capital gains taxes are based on a taxpayer’s income and filing status.” – Janover.

So, if you’re the kind of commercial real estate investor who prefers short-term flipping, you’re going to be dealing with annual short-term capital gains taxes on your various investments. On the other hand, if you’re the kind of investor who buys commercial properties and manages them (directly or via a property management company) for years to come, you’ll be looking at long-term capital gains taxes when you finally sell.

The specific tax brackets for capital gains, for both short-term and long-term capital gains, are published annually by the IRS. Capital gains are a progressive tax bracket system, meaning that the first $X is taxed at some percentage, the range from $X to $Y is taxed at another, higher bracket, and then anything higher than $Y is taxed at another bracket. It’s tricky, but it’s part and parcel of scaled tax brackets.

You can read every possible detail you could want to know about federal capital gains taxes directly from the IRS, and of course, you can always talk to your accountant to help you with them. You can also read it in a more easily digestible format from Investopedia.

All of this is somewhat beside the point, however. You’ve come here because you want to know about the tax on commercial real estate sales in California, not generic information across the country.

State-Level Capital Gains Taxes in California

Now let’s get into the second of three taxes you have to concern yourself with when you’re selling commercial real estate in California: the state-level taxes.

Luckily – perhaps – this is easier than you might think. California does not have its own capital gains taxes. It also does not distinguish between short-term and long-term asset sales, so you don’t need to worry about multiple classifications.

Instead, all you need to worry about is your overall income taxes. Capital gains are simply considered income and are taxed appropriately in conjunction with any other income you make.

Calculating income tax is at once easier and more difficult than capital gains taxes. It’s easier because there’s one simple progression of income tax brackets, but it’s more difficult because you have to consider factors like the cost basis of the property, the array of possible deductions and deferments, and various loopholes you may be able to use to avoid some of those taxes. You also need to consider filing status, whether you’re an individual, married, and so on.

You can see a chart of California’s income tax brackets here from NerdWallet. California’s tax authority also produces similar charts and information each year, available from their website here.

In broad strokes, the tax brackets are 1%, 2%, 4%, 6%, 8%, 9.3%, 10.3%, 11.3%, and 12.3%. These specific percentages can be adjusted for inflation on an ongoing basis but are around the right scale to think about when you’re planning for taxes in the future.

It’s also possible to create a corporation and use that entity to handle your real estate transactions. This has some pros but many cons, so it’s often only recommended for larger national investors. If you’re only planning to own a few pieces of real estate in California, individual ownership or an LLC/partnership tend to be the way to go. In any case, there are tax implications for all of these, and it’s worth speaking with an accountant to know the specifics of your situation.

Remember as well that income taxes are an ongoing tax each year; you aren’t just taxed on the sale of the property but on the income that the property generates for you before you sell it. There are ways to manipulate this tax, like declaring depreciation, but that’s all the subject of another post for another time.

Local Capital Gains Taxes on Commercial Real Estate Sales in California

The third of the three kinds of taxes that may apply to you are local-level taxes. Various county and city governments can have their own taxes on property exchanges within their borders. These are often called transfer taxes, and they trigger whenever a property is sold.

These vary from location to location. Some cities in California do not have them at all. Others have a token tax meant to scrape off a little income for the city but still be minimal enough it’s not really felt. Others are larger taxes meant to provide significant revenue for a city.

Los Angeles is currently the hot topic for this because the new transfer tax (also called the Mansion Tax and more formally known as Proposition ULA) was passed and went into effect this year.

Los Angeles’ tax is a simple three-tier system. For properties – both residential and commercial – sold for under $5m, nothing happens. Properties sold for between $5m and $10m incur a 4% tax paid to the city. Properties sold for over $10m see that tax rate raised to 5.5%. The proposition was passed with 57% of the vote and is in effect now; anyone selling commercial real estate for over $5m from here on out will need to be aware of this tax.

This and similar propositions tend to have relatively broad community support while being fiercely opposed by real estate investors and other property ownership companies. The reasons are obvious when millions of dollars are involved.

On the one hand, this proposition was meant to provide significant additional revenue to the city. On the other hand, it had a chilling effect on property sales, with very few properties over $5m sold since. 

At the same time, commercial real estate is struggling. In particular, skyscrapers and office buildings, as well as hotels and other commercial buildings, find themselves fighting to pay their bills and break even because societal pressures have suppressed return-to-office initiatives and a lot of in-person travel. That, too, is a discussion for another time, however.

Los Angeles isn’t the only city in California to enact these kinds of transfer taxes. 

“San Francisco already has one that calls for 0.75% to be paid on properties selling for more than $1 million, 2.25% for properties selling for more than $5 million, 5.5% for properties selling for more than $10 million, and 6% for properties selling for more than $25 million. Santa Monica near Los Angeles enacted a transfer tax in November 2022 of $56 per $1,000 of value for property transfers of $8 million or more.

Culver City, also near Los Angeles, enacted a transfer tax in April 2021 that’s tiered and no higher than 4% on property sales of more than $10 million. Culver City’s transfer tax also is capped at 0.45% for sales involving affordable housing and the first transfer of newly constructed multifamily housing.” – Costar.

This is all something you need to check into for your local municipality and be aware of when you decide to sell so you aren’t blindsided by an unexpected tax.

How to Minimize or Avoid Taxes on Commercial Real Estate Sales in California

Commercial real estate investors are generally quite concerned with taxes related to their investments for obvious reasons. There are some ways to minimize or cut down on the taxes you’ll owe, though they aren’t always going to be viable.

One option, if your commercial real estate is residential, is to occupy it for at least two years. Owner-occupied commercial real estate is allowed an exemption for either a quarter or half a million dollars when it’s sold, depending on if you’re single or married when you file those taxes. There are also occasional partial exemptions available.

By talking with an accountant and carefully reviewing the full history of investment and improvement into the property, you can also increase the cost basis of the property. Since the amount you’re taxed on is not the sale amount but the profit of the sale, increasing the cost basis means you can sell the property for less on-paper profit and thus pay less tax on it.

Similarly, you can sell your property for an on-paper loss. While it’s never pleasant to sell an investment for a loss, sometimes the cash in hand now is better than the hypothetical cash in hand later. Coupled with current downward pressures on certain types of commercial real estate, you might be able to take advantage of these lower prices to avoid some significant amount of the gains taxes – or even run a capital loss.

Whatever the case may be, this is all more of a discussion between you and your accountant. I’m just here to help you sell your commercial real estate. If you have a commercial property that you want to sell, and you want to get the most out of it that you possibly can, why not give me a call? My seller representation service is one of the top-rated in California, and between aggressive, targeted marketing and an intimate familiarity with the market, I can make sure you’re satisfied with the results of your sale.

On the flip side, if you’re a buyer, I can also work with you to find great deals that suit your needs. Whether you’re looking for short-term income properties, long-term investment properties, both, or something in between, I can help you find what you need. All you need to do is drop me a line, and we can get started working together.