How To Avoid Paying Capital Gains Tax on a Rental Property

Like many professionals involved in this industry, you're probably wondering how to avoid paying capital gains tax on rental property. Rental real estate investing offers a convenient way for landlords and investors to increase their assets, with capital gains tax typically playing a significant role in these investments. The exact amount you may owe in capital gains tax can vary based on several factors.

With 2026 approaching fast, understanding how to legally defer or minimize capital gains taxes on your rental properties is crucial. While some landlords and investors may attempt to reduce or defer capital gain taxes on their own, expert guidance and support from 1-800Accountant, America's leading virtual accounting firm, is the most efficient route. We work as your trusted partner in maximizing post-sale profits while ensuring compliance with applicable IRS and state tax laws.

Read on to learn about strategies you can use to help avoid paying your capital gains tax, and how to reduce it with these four simple steps.

What Are Capital Gains Taxes?

Capital gains taxes are taxes owed after the sale of an asset. Depending on how long you’ve held onto the investment property, you'll pay tax on the asset. There are two types of capital gains taxes: long-term and short-term. 

• Long-term capital gains taxes apply to assets you’ve held for more than one year.

• Short-term capital gains taxes apply to assets you’ve held for one year or less. 

Long-term taxes have three tax rates, which will determine the amount you’ll owe. In contrast to long-term capital gains, profits from short-term capital gains are taxed as ordinary income.

2025 vs. 2026 long-term capital gains thresholds

How Do Capital Gains on Investment Properties Work?

Capital gains for investment properties work like other assets. A capital gain occurs when you sell an asset for more than you paid. Capital gains are realized when you subtract the purchase price from the sale price, with depreciation recapture impacting your total taxable gain. It increases the gain by requiring you to pay taxes on the profit received from previous depreciation deductions, often at a high rate. This is triggered when you sell an asset for more than its adjusted cost basis.

Cost basis adjustments example

An investor purchases a rental income property for $300,000, which is the original cost/starting basis. Two years after the purchase, a roof replacement costing $20,000 was installed, which is a capital improvement. The investor claims $10,000 of depreciation for each of the five years of ownership, totaling $50,000, before selling the property for $400,000. This formula establishes the adjusted basis for this property:

Original cost + improvements – depreciation = adjusted basis

The adjusted basis for this sale would be $270,000. The passage of the One Big Beautiful Bill Act (OBBB) restored bonus depreciation, which can affect property improvements and recapture timing.

4 Strategies to Reduce or Lower Capital Gains Tax on Rental Properties

You can use these four rental property sale tax strategies to lower or reduce capital gains tax: 1031 exchanges, offsetting losses with gains, rental property conversion, and QOZ investment.

1. 1031 Exchanges

The first strategy you can use to lower capital gains tax involves 1031 exchanges. You can use section 1031 to sell a rental property while purchasing a like-kind property. 

Like-kind properties are properties of the same character or nature, even if their grade or quality differs (commercial, residential, and mixed-use). The exchange window and like-kind property definition remain under Section 1031.

If you defer paying capital gains taxes using 1031 exchanges, you’ll have to remember three deadlines:

• You’ll have 45 days from the property sale date to find potential replacement properties.

• You’ll have up to 180 days to close on the replacement property.

• If a tax return is due (with extensions) before the 180 days, you’ll need to close sooner. 

New IRS proposals could tighten reporting for QOZ investments and deferred exchanges — consider expert guidance from 1-800Accountant to ensure ongoing compliance.

2. Offset Losses with Gains (Tax-Loss Harvesting)

Another way to lower capital gains tax is to offset losses with gains. This option allows you to subtract losses from realized capital gains from a rental property sale. Losses from stock or REIT investments can also offset property gains you may receive.

You may consider this option if you’ve had capital losses in a tax year. IRS Form 8949, Sales and other Dispositions of Capital Assets, reconciles reported amounts with the amounts on your return. Form 8949 subtotals are then carried over to Schedule D (Form 1040), where gains or losses will be calculated. 

You may also consider a carryforward loss. If expenses from a rental activity exceed your rental income, the resulting net passive loss can be carried forward indefinitely to offset future passive income. Rent is considered passive income. 

3. Convert Rental to Primary Residence

Converting your rental into a primary residence is the third strategy you can use to lower capital gains tax.

By converting your rental into a primary residence in 2026, single taxpayers can exclude up to $250,000 from the rental property sale. Married taxpayers can exclude up to $500,000 if they’re filing jointly.

There are two things to know about qualifying for rental conversion into a primary residence:

1. You must have lived in the primary residence for two out of the five years before the sale. 

2. The years you must live in your primary residence don’t have to be consecutive.

The recent increase in the SALT deduction cap to $40,000 for AGI under $500,000 could indirectly benefit taxpayers by allowing them to offset capital gains via their property taxes.

4. Invest in Qualified Opportunity Zones (QOZ)

Starting in 2025, the OBBB made QOZs permanent. The federal government designates underprivileged and economically distressed areas as QOZs in an attempt to encourage investment and job creation. Investors who reinvest their capital gains into these communities are eligible for tax incentives. This reinvestment allows for deferral and potential exclusion of capital gains.

Did you know that investing in a QOZ within 180 days of a sale can defer or even eliminate capital gains tax on rental property profits?

How to Calculate Capital Gains Tax on a Rental Property

Capital gains tax on a rental property is calculated by subtracting the property's cost basis from its sale price. Your cost basis is the original purchase price plus any improvements made to the property. The total amount is then taxed at the required capital gains tax rate. You are not permitted to adjust the cost basis of an asset for inflation to calculate capital gains in 2026.

Example: $400,000 (sale) - $280,000 ($250k purchase + $30k improvements) = $120,000

2026 short-term capital gains tax rates

The following table provides an overview of the 2026 short-term capital gains tax rates for different taxable income ranges based on the taxpayer's filing status.

2026 long-term capital gains tax rates

The following table shows the income ranges for the long-term capital gains tax rates for the year 2026 based on the taxpayer's status.

Common Mistakes to Avoid

Navigating capital gains tax rules on behalf of your business while ensuring accuracy in your calculations is a complex task that's prone to errors. Avoiding these common errors ensures ongoing compliance.

• Failing to report depreciation recapture

• Missing 1031 exchange deadlines (45/180-day rules)

• Ignoring or failing to meet state-level capital gains obligations

• Not regularly tracking improvements for cost basis

• Selling before meeting primary residence criteria

Lower Your Tax Bill with 1-800Accountant On Your Side

For real estate investors and property managers, their capital gains tax liability can vary due to many factors. Whether your capital gain is long-term or short-term, you’ll want to fulfill your obligations when tax season arrives.

When it’s time to reduce your rental income taxes, make sure you work with CPAs, EAs, bookkeepers, and tax professionals who specialize in your state and industry. Discover how 1-800Accountant's team of tax professionals helps small business property owners and managers save an average of over $12,000 annually with personal income tax preparation, bookkeeping, and year-round tax advisory services.

Tax season is approaching. Schedule your free 30-minute consultation with one of our small business tax experts to ensure you're prepared.