Everything You Need to Know About Capital Gains Tax When Selling a Rental Property
Rental property owners know how complex their tax situations can be, especially if they address accounting themselves. Before you put a rental property on the market, it's important to understand what that can entail from a tax perspective. You'll have to acquaint yourself with several concepts, from depreciation recapture to 1031 exchanges, to capital gains tax.
Use this article to learn everything you need to know about the capital gains tax associated with the sale of your rental property. You'll gain an understanding of what capital gains taxes are, how to calculate them, and tactics to legally reduce or avoid them. You'll have a high-level view of capital gains taxes and how to handle them, but expert support is available. 1-800Accountant's real estate tax experts can guide you through the process to ensure the best results for your rental property sale.
Key Takeaways
Capital gains are the profit you make from the sale of your rental property.
You can calculate your capital gains with this formula: Capital Gain = Sale Price – Adjusted Basis.
Avoid capital gains taxes by making the property your primary residence or by a 1031 exchange, among other tactics.
Numerous deductions can be claimed when you sell a rental property.
Full-service tax support is available to handle these obligations on your behalf.
What are capital gains on a rental property?
So, is the capital gains tax for selling property? According to the Internal Revenue Service (IRS), capital gains on a rental property are the profits made from the sale of real estate assets. When these transactions are not profitable, they’re referred to as capital losses. Depreciation recapture is a rule that taxes the gain of the sale of a depreciated rental property asset – more on that later in this article. Special rules apply with regard to the basis for your gain or loss when an asset is received as a gift or inheritance.
Capital gains and losses are considered either long-term or short-term.
If you retain an asset for a year or more before selling or disposing of it, it’s considered long-term.
Anything shorter than a year is considered short-term.
Special rules apply for a property acquired from a decedent or patent property, commodity futures, and applicable partnership interests. Report the gain or loss on the sale of rental property on one of the following forms, depending on the purpose of the rental activity.
Individuals typically use Schedule D (Form 1040), Capital Gains and Losses, together with IRS Form 4797 or IRS Form 8949.
How to Calculate Capital Gains on a Rental Property
It's important to accurately calculate capital gains tax to determine what you owe capital gains tax. Determining the capital gains on the sale of your rental property requires this formula:
Capital Gain = Sale Price – Adjusted Basis
Your rental property's Adjusted Basis is the net cost of the property or asset after accounting for wear and tear and improvements. There are four main components of Adjust Basis:
Original purchase price. The initial purchase price, in addition to closing costs.
Capital improvements. Renovations and other expenditures that add value to the rental property.
Accumulated depreciation. The total depreciation deductions allowed or taken during the time you owned the rental property.
Selling expenses. Advertising, legal fees, and other costs incurred to sell the asset.
Adjusted Basis = Selling Expenses – Depreciation – Improvements + Original Price
What Is Depreciation Recapture?
Depreciation recapture applies to real estate sold, including:
Office buildings
Warehouses
Rental properties
Section 1250 governs depreciation recapture on the sale of your rental property, taxing gains attributable to accelerated depreciation as ordinary income and other depreciation as an unrecaptured Section 1250 gain. The maximum recapture rate is 25%.
Depreciation Recapture Example
Your $300,000 rental property with $50,000 in total depreciation sells for $350,000. The sale results in a $100,000 total gain, with half taxed as recapture (a roughly $12,500 bill when taxed at the maximum rate) and the other half taxed as capital gains.
2025 Capital Gains Tax Rates
The 2025 short-term capital gains tax rates are based on federal income tax rates. There are seven income tax brackets, ranging from 10% for the lowest income earners to 37% for the highest. 2025 long-term capital gains rates fall in a range of three percentage categories based on your income and filing status.
A 0% capital gains rate applies if taxable income is less than or equal to:
$48,350 for single and married filing separately
$96,700 for married filing jointly
$64,750 for head of household
A 15% capital gains rate applies if your taxable income is:
More than $48,350 but less than or equal to $533,400 for single
More than $48,350 but less than or equal to $300,000 for married filing separately
More than $96,700 but less than or equal to $600,050 for married filing jointly
$64,750 but less than or equal to $566,700 for head of household
A 20% capital gains rate applies if your income exceeds 15% capital gains thresholds.
It's also important to understand the Net Investment Income Tax (NIIT). It is a 3.8% tax on the lesser of your net investment income or the amount by which your Modified Adjusted Gross Income exceeds $200,000 for single and head of household filers, and $250,000 for married filing jointly. NIIT applies to:
Interest
Dividends
Capital gains
rental and royalty income
Nonqualified annuities
How to Reduce or Avoid Capital Gains Tax
There are several ways to reduce or lower capital gains on your rental property:
1031 Exchanges
Offset Losses with Gains
Convert Your Rental to a Primary Residence
Installment sales
Increases to your Adjusted Basis
1031 Exchanges
A section 1031 exchange enables you to sell a rental property while purchasing a like-kind property. It defers, but it does eliminate your tax liability. If you defer paying your capital gains taxes through a 1031 exchange, remember:
You have 45 days after the property sale date to search for potential replacement properties
You have up to 180 days to close on a replacement property
If your tax return is due (with extensions) before 180 days, you need to close sooner
Offset Gains With Losses
If you’ve had capital losses in a given tax year, consider subtracting your losses from realized capital gains on a rental investment property sale. You would do this to offset any losses you might have. It's important to understand capital loss carry-forward rules.
These rules allow you to carry forward unused net capital losses indefinitely to future years. Losses must first offset capital gains in the current year. Excess losses up to $3,000 can offset ordinary income, with the remainder carried forward until it's fully exhausted.
Convert to a Primary Residence
Convert your rental into a primary residence, and you can exclude up to $250,000 from the sale of the property or up to $500,000 if married and filing jointly. The primary residence exclusion is valuable, but strict eligibility requirements must be followed.
For your property to qualify as a primary residence, you must have lived in it for two out of five years before selling. Those two years can be non-consecutive.
If you meet the ownership and use tests under section 121 of the Internal Revenue Code, you may be able to exclude much of the gain from the sale of your main home that you also used to produce rental income. However, you may not exclude gain from the sale or exchange of your main home if it's allocable to periods of nonqualified use.
If your property was used as a rental after January 1, 2009, but before becoming your primary residence, a portion of the gain may be taxable due to nonqualified use, even if you lived in the home for the required period.
Installment Sales
Instead of receiving payment for the sale of your rental property all at once, you can spread the capital gain over multiple years through an installment sale. In this scenario, you report gains proportionally as payments are received using IRS Form 6252, Installment Sale Income.
The main appeal of installment sales is that they help lower your taxable income.
Increase Your Adjusted Basis
Increasing your Adjusted Basis is another way to reduce capital gains. By increasing costs, you lower your taxable profit. Do this via capital improvements, such as renovations or a new roof, and closing fees from your rental property's sale.
It's important to retain records of each capital improvement, as well as depreciation tracking. Tracking your rental property's depreciation is essential as it reduces your basis over time and triggers depreciation recapture taxes upon its sale.
What Deductions Can You Claim When Selling a Rental Property?
Deductions provide more immediate tax relief, while basis adjustments provide long-term tax benefits. Basis adjustments are improvements that increase your rental property's cost basis, reducing capital gains tax when it's sold.
Many of the business expenses you incurred during the sale of your rental property qualify as tax deductions. While a qualified tax professional can select all deductions that apply to your tax situation, here are common examples of deductions that you can claim when selling your rental property:
Realtor commissions
Closing costs
Legal fees
Owner's title insurance
Transfer taxes
Marketing and advertising expenses
Property taxes paid during the sale process
Other closing costs
Suppose a property serves as a principal residence before being converted to a rental and eventually sold. In that case, you might be eligible to exclude the capital gains from the sale on your tax return. Consult with a qualified real estate tax professional to explore your eligibility.
State Taxes on Rental Property Sales
While much of the focus is on federal taxes, state tax planning is important.
State taxes on the sale of your rental property are usually levied by the state where it is located, with some states taxing capital gains as ordinary income. Multi-state property issues can arise if you reside in a different state than your rental property is located in, requiring you to file a non-resident return.
Work With Real Estate Tax Experts
Expertly managing capital gains taxes on the sale of your rental property can be complex. Ensure you're in the strongest tax position with expert real estate tax support from 1-800Accountant, America's leading virtual accounting firm. When you trust us with your real estate financial work, you get:
A dedicated real estate accountant experienced in navigating the tax nuances of your state
Rental property tax expertise
1031 coordination
Quarterly tax planning and adjustments
Whether you're currently selling or thinking about it, time is of the essence. Schedule a free 30-minute consultation today to learn more about our suite of financial services for rental property professionals and to get started.
FAQs About Capital Gains on Rental Property
How is depreciation recapture calculated?
Depreciation recapture can be calculated in three steps. First, determine your Adjusted Basis, and then calculate the total gain. After that, identify the recapture amount.
Can I avoid capital gains tax entirely?
Capital gains tax can be avoided or significantly reduced, but not eliminated, without planning. You might be able to avoid capital gains by using a home sale exemption, holding assets until they're no longer useful, donating appreciated assets to charity, or offsetting gains with losses. A tax professional can lay out your optimal path to capital gains avoidance.
What happens if I sell at a loss?
If you sell your rental property at a loss, you can likely report a capital loss. Typically, rental property losses are treated as ordinary losses if held for over a year, while losses from the sale of a personal residence are not deductible. Excess losses can be carried forward.
How long do I have to reinvest in a 1031 exchange?
There are two deadlines to strictly adhere to: the 45-day ID period and the 180-day closing period. You must identify a replacement property in writing within 45 days. Once identified, you have 180 days after the sale to close on the replacement.
Do I pay self-employment tax on rental property sales?
The 15.3% self-employment tax funds Social Security and Medicare. You would not pay self-employment tax as a result of the sale of your rental property. Instead, you would pay capital gains as a result of your rental property sale.
How does capital gains tax work if the property was inherited?
If the property was inherited, it's subject to a stepped-up basis. The property's value for tax purposes resets to its fair market value as of the decedent's date of death. In this scenario, you only pay capital gains tax on appreciation after that date, and the rate is usually favorable.
Does selling rental property affect my estimated taxes?
Yes, selling your rental property impacts estimated tax reporting. Capital gains and depreciation recapture are considered taxable income. Include that income in the appropriate quarter in which you sell your rental property.