Short-Term vs Long-Term Capital Gains When a Property Sells

What is the difference between short-term and long-term capital gains when a property sells? A short-term capital gain arises when a property is sold after being held one year or less, and it is taxed as ordinary income at the seller's regular marginal rate. A long-term capital gain arises when the property was held for more than one year, and it is taxed at the lower federal capital gains rates of 0%, 15%, or 20%, depending on taxable income. For commercial real estate specifically, that one-year line interacts with a second rule, found in Internal Revenue Code Section 1231, that governs how gains and losses on business property are characterized and can change the outcome in ways the simple short-term and long-term labels do not fully capture.

Key Takeaways

• A property held one year or less produces a short-term gain taxed as ordinary income at the seller's marginal rate, which can run as high as 37%.
• A property held more than one year produces a long-term gain, taxed at 0%, 15%, or 20% depending on taxable income, before any depreciation recapture is applied.
• Real property used in a trade or business is generally Section 1231 property, and net 1231 gains are treated as long-term capital gain while net 1231 losses are treated as ordinary losses.
• A five-year lookback rule can convert what looks like a current-year 1231 gain into ordinary income if the taxpayer claimed 1231 losses in any of the preceding five years.
• The holding period is generally counted from the day after acquisition through the day of disposition, and it can carry over or reset depending on how the property was acquired.
• Depreciation recapture is calculated separately from the short-term and long-term question, and it applies regardless of how long the property was held.

Tax on a hypothetical $200,000 gain: 11 months held vs 13 months held

	Hypothetical tax owed on a $200,000 gain
Held 11 months (short-term, 32% rate)	$64K
Held 13 months (long-term, 15% rate)	$30K

Illustrative arithmetic to show the mechanism, not market data.

The One-Year Test That Separates Short-Term From Long-Term

The test is a single question: was the property held for more than one year before it was sold, or for one year or less? IRS Topic 409 states that if an asset is held for more than one year before it is disposed of, the gain or loss is long-term, and if it is held one year or less, the gain or loss is short-term. There is no partial credit and no rounding in the seller's favor.

The counting method matters more than most sellers expect. Topic 409 explains that the holding period is generally counted from the day after the date of acquisition through the day of disposition. A property purchased on March 15 of one year and sold on March 15 of the following year has been held exactly one year under that count, which means the sale falls on the short-term side of the line. Selling even one day later, on March 16, crosses into long-term treatment. That single day can be worth a meaningful difference in tax owed on an identical dollar of gain, which is covered in the next section.

This test applies to the property as a capital or Section 1231 asset in the hands of the current owner. It does not ask how long the seller has owned an interest in the entity holding the property, how long the entity itself has existed, or how the seller feels about the investment. It is a calendar question with a factual answer, and it is worth confirming against the closing documents on both ends of the hold rather than estimating it from memory.

Why the Rate Difference Is Large Enough to Change a Sale Decision

Short-term gains are taxed at the same graduated rates that apply to wages, which for 2026 run as high as 37% at the top of the bracket. Long-term gains are taxed under a separate rate schedule that tops out at 20%, with a 0% rate available to lower-income filers and a 15% rate covering most taxpayers in between. The gap between those two schedules is the entire reason the one-year line gets this much attention.

For 2026, the IRS set the 0% long-term rate for single filers at taxable income up to $49,450 and for married couples filing jointly up to $98,900, the 15% rate running from there up to $545,500 for single filers and $613,700 for joint filers, and the 20% rate applying above those thresholds. A short-term gain receives none of that preferential treatment. It stacks on top of a seller's other income and is taxed at whichever marginal bracket, up to 37%, that income lands in.

In a hypothetical using round numbers chosen for arithmetic rather than drawn from any transaction, a $200,000 gain taxed at a hypothetical 32% ordinary rate produces a $64,000 federal tax bill if the property was held eleven months. The identical $200,000 gain, on the identical property, sold two months later at the thirteen-month mark, is taxed at a 15% long-term rate and produces a $30,000 bill. As the comparison shows, the only variable that changed was the calendar, and the difference is $34,000 on the same transaction. Net investment income tax can apply on top of either figure for taxpayers above the relevant income thresholds, and state tax is calculated separately from both.

Section 1231: The Rule That Governs Most Commercial Property Sales

Real property and depreciable property used in a trade or business, held for more than one year, is generally Section 1231 property rather than an ordinary capital asset, and Section 1231 has its own characterization rule that sits on top of the short-term and long-term distinction described above. A rental building, a net-leased retail property, or an office property held for business or investment use typically falls into this category once it clears the one-year holding period.

IRS Publication 544 explains that gains and losses from the sale or exchange of property used in a trade or business are combined with certain other gains and losses to determine whether the result is treated as a capital gain or an ordinary loss. The combination happens first at the Section 1231 level: all of a taxpayer's 1231 gains and losses for the year are netted against each other before the result is characterized for tax purposes.

The outcome of that netting is asymmetric, and the asymmetry favors the taxpayer in the ordinary case. If the net result for the year is a gain, it is treated as long-term capital gain, eligible for the preferential rates described above. If the net result is a loss, it is treated as an ordinary loss, fully deductible against ordinary income rather than subject to the capital loss limitations that apply to a typical investment loss. A property held exactly the required period, sold at a gain, in a year with no other 1231 transactions, simply follows the long-term capital gain rate schedule. The complication arrives when a taxpayer has more than one 1231 transaction in recent years, which is covered next.

The Five-Year Lookback That Can Turn a 1231 Gain Into Ordinary Income

A net Section 1231 gain in the current year is not automatically long-term capital gain if the taxpayer claimed a net 1231 loss as an ordinary deduction in any of the five preceding tax years. This nonrecapture rule exists to prevent a taxpayer from taking an ordinary loss deduction one year and a preferential capital gain rate the next year on what is, in substance, the same category of property activity.

The mechanism works by recharacterizing part of the current gain. To the extent a current-year net 1231 gain does not exceed the nonrecaptured 1231 losses from the five prior years, that portion of the gain is treated as ordinary income rather than long-term capital gain. Only the amount of gain exceeding the unrecaptured prior losses receives long-term treatment. A taxpayer who deducted a $150,000 ordinary 1231 loss two years ago and then realizes a $150,000 1231 gain this year would generally have that entire gain treated as ordinary income, with nothing left over to receive the preferential rate.

This rule is one of the reasons a seller cannot determine the tax treatment of a single property sale by looking at that sale in isolation. The full picture requires knowing every Section 1231 transaction across the current year and the five years before it, including sales of other business or investment real estate and certain casualty or condemnation events. For an investor holding property through a fund, that history belongs to the fund entity rather than to the individual investor, and the allocation of any recharacterized gain arrives through the partnership's own reporting.

How the Holding Period Is Calculated, and Where It Resets

The starting point for the holding period is normally the closing date on which the property was acquired, and the clock runs forward from the day after that date. Several common transactions change where that clock starts, and knowing which rule applies before a sale closes is more useful than discovering it afterward.

A property acquired through a Section 1031 like-kind exchange generally carries over the holding period of the property given up, which is why an exchange completed shortly before a sale does not reset the clock back to zero the way an outright purchase would. A property improved with substantial construction or additions generally has a separate holding period for the improvement itself, measured from when that specific improvement was placed in service, even though the land and the original structure keep their own original holding period. A property received as a gift generally carries over the donor's holding period, while a property acquired from a decedent's estate typically receives a fresh start with its own holding period beginning at the date of death, alongside a stepped-up basis.

None of these carryover or reset rules is optional or elective. Each one is a factual determination tied to how and when the specific interest in the property was acquired, and the correct answer can depend on documents, dates, and elections made years before a sale is contemplated. Confirming the applicable holding period rule before closing, rather than assuming the most recent purchase date controls, is worth the time on any transaction where the acquisition history is not a single simple purchase.

What a 1031 Exchange and Depreciation Recapture Do to the Holding-Period Question

Depreciation recapture is calculated separately from the short-term versus long-term question and applies regardless of how long a property was held, which is a distinction worth stating plainly because the two issues are often discussed together and then conflated. A seller who clears the one-year threshold and qualifies for long-term treatment on the appreciation portion of a gain still faces recapture on the depreciation already claimed, and that recapture is taxed under its own rules rather than at the standard long-term capital gains rate. How that split works, including the maximum 25% rate on unrecaptured Section 1250 gain, is covered in the guide to depreciation recapture at sale.

A Section 1031 exchange changes the timing of the entire question rather than the rate applied to it. Deferring a gain through an exchange postpones the point at which any of this analysis matters, since no gain is currently recognized, but it also carries the original property's holding period, its basis, and its accumulated depreciation forward into the replacement property. The holding-period and recapture questions described in this article simply wait for the eventual taxable sale, as explained in the guide to 1031 exchange timelines. Neither a 1031 exchange nor the long-term capital gains rate changes the depreciation deductions a cost segregation study accelerated into earlier years, described in the guide to how a cost segregation study splits a building into separate depreciation schedules, since those deductions are recaptured on their own terms at sale regardless of the holding period result.

For an investor holding property through a fund, the entity performs this entire analysis at the partnership level, and the result arrives as a coded figure on the investor's own Schedule K-1 rather than as a calculation the investor performs directly. The character of the gain, whether it is long-term, short-term, or recharacterized under the five-year lookback, is determined by the fund's own transaction history and reported to each investor accordingly.

Every determination described in this article depends on facts specific to the taxpayer, including the exact acquisition and disposition dates, the taxpayer's other income, filing status, and any other Section 1231 transactions in the current or preceding five years. Freedom Commercial Real Estate does not provide tax advice, and nothing in this guide is tax advice. Whether a specific sale qualifies for long-term treatment, and what rate would actually apply, is a question for your own CPA or tax advisor.

Freedom Commercial Real Estate publishes guides like this one so investors can understand how a sale's timing interacts with the tax code before a closing date is ever chosen. Questions about anything covered here, or a tax mechanic worth explaining next, can go straight to the team at info@freedomcre.net.

Frequently Asked Questions

Q: How exactly is the one-year holding period counted for real estate?

A: IRS Topic 409 counts the holding period starting the day after the date of acquisition through the day of disposition. A property purchased on a given date and sold exactly one year later, to the day, has not yet cleared more than one year and is treated as short-term. Selling even one day after that anniversary date puts the sale on the long-term side of the line.

Q: Does Section 1231 apply to every piece of commercial real estate?

A: It generally applies to real property and depreciable property used in a trade or business and held for more than one year. Property held primarily for personal use, or held for one year or less, does not qualify as Section 1231 property and is analyzed under the ordinary short-term and long-term capital asset rules instead. Whether a specific property qualifies depends on its use and holding period, which is a question for a tax advisor on close cases.

Q: Can a long-term capital gain still be taxed as ordinary income?

A: Yes, in two common situations. Depreciation recapture taxes part of the gain under separate rules regardless of holding period, and the Section 1231 five-year lookback rule can recharacterize part or all of a current-year net 1231 gain as ordinary income if the taxpayer claimed net 1231 losses as ordinary deductions in any of the preceding five years. Both rules are applied before, or alongside, the standard long-term rate schedule.

Q: Does a 1031 exchange change the holding period analysis?

A: A 1031 exchange defers the gain rather than resetting the holding period. Replacement property acquired through an exchange generally carries over the holding period, the basis, and the accumulated depreciation of the property given up, so the short-term, long-term, and recapture questions covered in this article apply to the eventual taxable sale of the replacement property rather than disappearing.

Q: How does this apply if I hold real estate through a fund rather than directly?

A: The fund entity performs the holding-period, Section 1231 netting, and recapture analysis at the partnership level based on its own acquisition and disposition history, and the character of the resulting gain, whether long-term capital gain, ordinary income under the five-year lookback, or depreciation recapture, is reported to each investor on their Schedule K-1 rather than calculated by the investor directly.

Sources

• Internal Revenue Service, Topic No. 409: Capital Gains and Losses
• Internal Revenue Service, Publication 544: Sales and Other Dispositions of Assets
• Internal Revenue Service, Tax Inflation Adjustments for Tax Year 2026

This article is for informational purposes only and is not an offer to sell or a solicitation of an offer to buy any security, nor investment, tax, or legal advice. Any offering is made only through official offering documents to verified accredited investors. Past performance does not guarantee future results.