Selling Rental Property: Capital Gains, Depreciation Recapture & Tax Strategies
Selling a rental property triggers multiple tax consequences: capital gains, depreciation recapture, Net Investment Income Tax, and state taxes. Understanding these before you sell can save you tens of thousands. Here's the complete playbook.
In This Guide
1. How to Calculate Your Gain
Your taxable gain isn't simply sale price minus purchase price. You must account for your adjusted basis, which changes over time:
Adjusted Basis Calculation:
Original purchase price: $300,000
+ Closing costs added to basis: + $5,000
+ Capital improvements over time: + $25,000
- Depreciation taken (or allowed): - $58,182
= Adjusted basis: $271,818
Gain Calculation:
Sale price: $420,000
- Selling expenses (agent, closing): - $26,000
- Adjusted basis: - $271,818
= Total gain: $122,182
Critical: Depreciation reduces your basis whether or not you actually claimed it. The IRS uses "depreciation taken OR allowed" — meaning even if you forgot to take depreciation for years, your basis is still reduced. This makes accurate tracking from Day 1 essential.
2. Capital Gains Tax Rates (2026)
If you owned the property for more than one year, your gain (minus the depreciation recapture portion) is taxed at long-term capital gains rates:
| Taxable Income (Single) | Capital Gains Rate |
|---|---|
| Up to $48,350 | 0% |
| $48,351 - $533,400 | 15% |
| Over $533,400 | 20% |
For most landlords, the effective combined federal rate on selling a rental property is: 15% capital gains + 25% depreciation recapture (on that portion) + 3.8% NIIT = up to 28.8% on the depreciation recapture portion and 18.8% on the rest.
3. Depreciation Recapture (25% Tax)
When you sell, the IRS "recaptures" the depreciation you took (or were allowed to take) at a special rate of 25% — higher than the standard 15% long-term capital gains rate. This is reported on Form 4797 and Schedule D.
Breaking Down the $122,182 Gain:
Total depreciation taken: $58,182 — taxed at 25% = $14,546
Remaining gain: $64,000 — taxed at 15% = $9,600
NIIT on full gain: $122,182 × 3.8% = $4,643
Total federal tax: $28,789 (23.6% effective rate)
For more details, see our Depreciation Recapture Explained guide.
4. Net Investment Income Tax (3.8%)
If your MAGI exceeds $200,000 (single) or $250,000 (married filing jointly), you owe an additional 3.8% tax on the lesser of your net investment income or the amount your MAGI exceeds the threshold.
Capital gains from selling rental property ARE net investment income. The only exception is if you qualify for REPS (Real Estate Professional Status) AND materially participate — in which case the gain may not be subject to NIIT. See our NIIT Tax Guide for more details.
5. 1031 Exchange (Defer All Taxes)
A 1031 exchange (like-kind exchange) lets you defer ALL taxes — capital gains, depreciation recapture, and NIIT — by reinvesting the proceeds into another qualifying investment property.
Key Rules
- 45-day identification period: You must identify potential replacement properties within 45 days of closing
- 180-day closing period: You must close on the replacement property within 180 days
- Qualified intermediary: A third-party QI must hold the funds — you can NEVER touch the money
- Like-kind property: Any real property held for investment qualifies (residential to commercial is fine)
- Equal or greater value: To defer ALL tax, the replacement must cost at least as much as the sale price
- All cash reinvested: Any cash you take out ("boot") is taxed in the current year
Tax Savings: In our example above, a 1031 exchange would defer the entire $28,789 in taxes. If you continue doing 1031 exchanges until death, the deferred gain gets a stepped-up basis — your heirs inherit tax-free.
Read our comprehensive 1031 Exchange Guide for the full process.
6. Installment Sales
An installment sale (seller financing) lets you spread the gain over multiple years by receiving payments over time. You only pay tax on the gain portion of each payment received. This can keep you in lower tax brackets.
Example: $420K Sale with 20% Down, 10-Year Seller Financing
Gross profit ratio: $122,182 gain ÷ $420,000 sale price = 29.1%
Each year's payment of $42,000 × 29.1% = $12,222 taxable gain per year
Instead of $122,182 in one year, you spread it over 10 years at $12,222/year
Plus: You earn interest income on the unpaid balance (required: at least AFR rate)
Limitation: Depreciation recapture is taxed in the year of sale regardless of installment method. Only the capital gain portion beyond recapture can be spread. In our example, the $58,182 recapture is taxed in Year 1.
7. Primary Residence Conversion Strategy
IRC Section 121 lets you exclude up to $250,000 ($500,000 if married) in gain when selling your primary residence — if you lived in it for 2 of the last 5 years. Some landlords convert rentals to primary residences to access this exclusion.
How It Works
- Stop renting the property and move in as your primary residence
- Live there for at least 2 full years
- Sell the property and claim the Section 121 exclusion
Limitations (Post-2008 Rules)
- Non-qualified use: Gain allocable to periods of non-qualified use (time after 2008 when it was NOT your primary residence) is not excludable
- Depreciation recapture: You can NEVER exclude depreciation recapture — it's always taxed at 25% regardless of the Section 121 exclusion
- 5-year lookback: You must have owned and lived in it for 2 of the 5 years preceding the sale
8. How SheltrIQ Models Your Sale
Before selling, you need to know exactly what you'll owe. SheltrIQ gives you the full picture:
Sale Tax Calculator
Input your expected sale price and instantly see capital gains, recapture, NIIT, and state taxes owed.
1031 Exchange Planner
Model a 1031 exchange scenario showing how much you'd need to reinvest to defer 100% of taxes.
Basis Tracker
Maintains accurate adjusted basis from Day 1 — including all improvements and depreciation taken.
Suspended Loss Release
Shows how suspended passive losses will offset your gain upon sale, reducing your actual tax bill.