Capital Gains Tax on Real Estate: Rates, Exclusions, and 1031 Exchanges

Capital gains tax on real estate applies to the profit you make when you sell property, and the rate depends on how long you owned it, what you used it for, and your total income. For 2026, long-term gains face federal rates of 0%, 15%, or 20%, with an extra 3.8% surtax for higher earners. If the property was your main home, you may be able to exclude up to $250,000 of gain ($500,000 for married couples filing jointly). Rentals carry an additional layer called depreciation recapture, taxed at up to 25%. Inherited property gets a stepped-up basis that often wipes out most of the taxable gain.

How the Taxable Gain Is Calculated

Your capital gain is the difference between what you net from the sale and your adjusted basis in the property. Both numbers move, and both matter.

Adjusted basis starts with your purchase price plus acquisition costs paid at closing, such as title insurance, recording fees, survey fees, and legal fees. Add the cost of capital improvements made during ownership: a new roof, a kitchen remodel, an added bathroom, an HVAC system, fencing. Routine repairs and maintenance do not count. Painting a room, patching drywall, or fixing a faucet keeps the home functional but does not increase basis.¹

If you claimed depreciation on investment property, those deductions reduce your basis. So do insurance reimbursements for casualty losses. That is why a long-held rental produces a larger taxable gain than sellers often expect.

On the selling side, your amount realized is the sale price minus selling expenses. Real estate commissions, transfer taxes, seller-paid title insurance, legal fees, and advertising costs all come off the top.¹ Every dollar of legitimate expense is a dollar of gain you do not pay tax on, so keep records through the entire ownership period.

Short-Term vs. Long-Term Gains

How long you owned the property decides which tax rates apply. Property sold after one year or less produces a short-term capital gain, taxed at ordinary income rates. Property held for more than one year produces a long-term capital gain at the lower preferential rates.²

Short-term rates currently run from 10% to 37%. A seller flipping a property inside a year could hand over more than a third of the profit in federal tax alone. Long-term rates top out at 20%, and many sellers qualify for 15% or even 0%. The one-year line is one of the most consequential dates in real estate tax planning.

2026 Long-Term Capital Gains Rates

Long-term rates are tiered at 0%, 15%, and 20%. The rate you pay depends on your total taxable income, not the size of the gain alone. For tax year 2026, the IRS adjusted the thresholds for inflation:³

0% rate: taxable income up to $49,450 (single), $98,900 (married filing jointly), $49,450 (married filing separately), or $66,200 (head of household).
15% rate: taxable income from $49,451 to $545,500 (single), $98,901 to $613,700 (married filing jointly), $49,451 to $306,850 (married filing separately), or $66,201 to $579,600 (head of household).
20% rate: taxable income above $545,500 (single), $613,700 (married filing jointly), $306,850 (married filing separately), or $579,600 (head of household).

Most sellers land in the 15% bracket. The 0% rate is worth more attention than it gets. A retired couple with modest pension income and a $60,000 gain can owe nothing in federal capital gains tax if total taxable income stays under $98,900.

The 3.8% Net Investment Income Tax

Higher-income sellers may owe an additional 3.8% surtax on real estate gains. The Net Investment Income Tax applies when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.⁴ These thresholds are not indexed for inflation, so they catch more taxpayers each year.

The tax is calculated on the lesser of your net investment income or the amount by which MAGI exceeds the threshold. A married couple with $300,000 in MAGI and $100,000 of net investment income from a sale would owe the 3.8% on $50,000, not on the full $100,000.⁵

Gain excluded under the primary residence exclusion is not counted as net investment income. Any gain above the exclusion limit is.⁵

State Capital Gains Taxes

Federal tax is not the whole bill. Most states tax capital gains from real estate at their ordinary income rates, from 0% in states without an income tax to more than 13% in the highest. A few states offer reduced rates or partial deductions. Sellers in high-tax states can face a combined federal-and-state rate approaching 35% or more on long-term gains, so check your state’s treatment before closing.

Excluding Gain on a Primary Residence

The Section 121 exclusion is the single most valuable tax break in residential real estate. If you sell your main home, you can exclude up to $250,000 of capital gain from income. Married couples filing jointly can exclude up to $500,000.⁶ Anything above the exclusion is taxed at the applicable long-term rate.

Two requirements apply. You must have owned the home for at least two of the five years before the sale, and you must have used it as your principal residence for at least two of those five years. The two years do not have to run consecutively. Twenty-four scattered months of qualifying use is enough. For joint filers, only one spouse needs to meet the ownership test, but both must meet the use test. You also cannot have claimed the exclusion on another home sale within the two years before this one.⁶

Partial Exclusion When You Sell Early

Sellers who fall short of the two-year requirement are not automatically shut out. A partial exclusion is available when the sale is prompted by a change in employment, health reasons, or other unforeseen circumstances such as divorce or natural disaster.⁶

The exclusion is prorated. Take the fraction of the two-year requirement you actually met and apply it to the full $250,000 or $500,000 cap. A single filer who lived in the home for 12 months before a qualifying job relocation could exclude up to 12/24 of $250,000, or $125,000.

Periods of Non-Qualified Use

If you used the property for something other than a primary residence during part of your ownership, such as renting it out, the portion of your gain allocated to that non-qualified use cannot be excluded. The allocation is a simple ratio: total non-qualified use divided by total ownership.⁷

Several exceptions soften the rule. Any period after the last date you used the property as your principal residence does not count as non-qualified use. Neither do temporary absences of up to two years for employment changes, health conditions, or unforeseen circumstances. Military families get broader relief, with up to ten years of qualified official extended duty excluded from the non-qualified use calculation.⁷ A homeowner who lives in the property first and rents it out later faces a smaller penalty than one who rents first and moves in later.

Investment Property: Depreciation Recapture and 1031 Exchanges

Rental and other investment properties do not qualify for the Section 121 exclusion, and they carry an extra tax layer that surprises many sellers.

Depreciation Recapture

Annual depreciation deductions reduce your taxable rental income while you own the property, and they also reduce your adjusted basis. When you sell, the IRS claws back the tax benefit on the depreciated amount. Recaptured gain is taxed at a maximum rate of 25%, regardless of your income bracket.⁸ Any remaining gain above the recaptured amount is taxed at the standard 0%, 15%, or 20% long-term rate.

Say you bought a rental for $300,000, claimed $80,000 in depreciation over the years, and sold for $450,000. Your adjusted basis is $220,000, giving you a total gain of $230,000. The first $80,000 is depreciation recapture taxed at up to 25%. The remaining $150,000 is taxed at the long-term rate. Higher-income sellers would also owe the 3.8% NIIT on top of both layers.

Deferring Tax With a 1031 Exchange

A Section 1031 exchange lets you sell an investment property and reinvest the proceeds into another investment property without recognizing gain at the time of sale. Both the capital gain and the depreciation recapture are deferred until you eventually sell the replacement property without exchanging again.⁹

The deadlines are unforgiving. From the closing date on the sale of your old property, you have 45 days to identify potential replacement properties in writing and 180 days to close on the replacement. These deadlines cannot be extended for any reason short of a presidentially declared disaster.¹⁰ Identification must include a specific description, such as a street address or legal description.

You also cannot touch the sale proceeds at any point during the exchange. The funds must flow through a qualified intermediary who holds the money between the sale and the purchase. If the proceeds hit your bank account even briefly, the exchange is disqualified and the full gain becomes taxable.

Inherited Real Estate and the Stepped-Up Basis

When you inherit real estate, the property’s tax basis resets to its fair market value on the date of the previous owner’s death. The stepped-up basis effectively erases the appreciation that accumulated during the original owner’s lifetime.¹¹ If your parent bought a house for $80,000 in 1985 and it was worth $400,000 at death, your basis is $400,000. Sell it for $410,000 and your taxable gain is $10,000.

Inherited property also qualifies automatically for long-term treatment, even if you sell it the day after inheriting it. Under federal law, property acquired from a decedent and sold within one year of death is treated as held for more than one year.¹² Heirs never face short-term rates on inherited real estate.

Selling at a Loss

Not every sale produces a profit, and the tax treatment of a loss depends on how you used the property. A loss on the sale of your primary residence or a vacation home is not deductible. The IRS treats losses on personal-use property as nondeductible.²

Investment property works differently. Losses on rentals and other real estate held for investment are capital losses that offset capital gains dollar for dollar. If your capital losses exceed your capital gains for the year, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately). Any remaining unused loss carries forward to future years indefinitely.²

How to Report the Sale

Most real estate sales go on Form 8949 (Sales and Other Dispositions of Capital Assets), with the totals flowing to Schedule D of Form 1040.¹³ The closing agent typically issues a Form 1099-S reporting the gross sale proceeds, which the IRS also receives.¹⁴

If you sold your primary residence and the gain is fully covered by the Section 121 exclusion, you may not need to report the sale at all, provided you receive no Form 1099-S and the gain does not exceed $250,000 (or $500,000 for joint filers). If a 1099-S was issued, report the transaction anyway so the IRS can match its records.¹⁵

Sellers who owe the 3.8% NIIT report it separately on Form 8960. Investment property sales involving depreciation recapture use Form 4797 in addition to Schedule D. Sellers completing a 1031 exchange file Form 8824 for the year of the exchange, even though no tax is owed that year.

1
Internal Revenue Service. Publication 523 (2025), Selling Your Home
2
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
3
Internal Revenue Service. Revenue Procedure 2025-32
4
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
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Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
6
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
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Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
8
eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain
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Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
10
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
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Internal Revenue Service. Gifts and Inheritances
12
Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
13
Internal Revenue Service. 2025 Instructions for Form 8949
14
Internal Revenue Service. Instructions for Form 1099-S, Proceeds From Real Estate Transactions
15
Internal Revenue Service. Topic No. 701, Sale of Your Home