When you sell an investment property, the profit can face up to four layers of federal tax: ordinary income rates if you held it a year or less, long-term capital gains rates of 0%, 15%, or 20% if you held it longer, depreciation recapture at up to 25% on the portion tied to depreciation you claimed, and a 3.8% net investment income surtax if your income is high enough. Most states add their own tax on top. What you actually owe depends on your holding period, your income, how much depreciation you took over the years, and whether you use a deferral strategy like a 1031 exchange or an installment sale.
Capital Gains Rates for 2026
Holding period does the first heavy lifting on your tax rate. If you owned the property for one year or less, the gain is short-term and taxed as ordinary income at your regular federal rate, which ranges from 10% to 37% for the 2026 tax year.1Internal Revenue Service. Topic No. 409, Capital Gains and Losses A short-term flip by someone in the top bracket loses more than a third of the profit to federal tax alone, before any other layer applies.
Held for more than one year, the gain qualifies for long-term capital gains rates. For 2026, those rates break down by taxable income:2Internal Revenue Service. Revenue Procedure 2025-32
- 0% on taxable income up to $49,450 (single) or $98,900 (married filing jointly).
- 15% from those thresholds up to $545,500 (single) or $613,700 (joint).
- 20% above those upper limits.
Most investment property sellers land in the 15% bracket. The 0% rate rarely comes into play, because the sale itself often pushes taxable income past the lower threshold. Track your acquisition and sale dates carefully. Missing the one-year mark by a single day makes the entire gain short-term.
Calculating the Gain
Your taxable profit is not sale price minus purchase price. The IRS uses your adjusted basis, which starts with your original purchase price and closing costs, then changes to reflect what happened financially while you owned the property.
Capital improvements increase your basis. A new roof, an added bathroom, a replaced HVAC system: each extends the property’s useful life and adds to what you have invested. Routine maintenance and repairs do not count. Working the other direction, every year of depreciation you claimed on your tax returns reduces the basis. For residential rental property, the IRS requires depreciation over 27.5 years using the straight-line method.3Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System Nonresidential investment property uses a 39-year schedule. Only the building depreciates, not the land.
To find the total gain, subtract the adjusted basis and selling expenses from the sale price. Selling expenses include real estate commissions, transfer taxes, advertising, legal fees, and any loan charges you paid that were normally the buyer’s responsibility.4Internal Revenue Service. Publication 523, Selling Your Home Sell a rental house for $500,000 with an adjusted basis of $310,000 and $40,000 in selling costs, and your total gain is $150,000. That figure feeds every calculation below.
Depreciation Recapture
This is where the bill grows in ways many sellers do not anticipate. Every dollar of depreciation you claimed comes back as a separate taxable event, and it is taxed at a higher rate than the long-term capital gains rates above.
The IRS calls this unrecaptured Section 1250 gain, and the maximum federal rate on it is 25%.5Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty If you owned a residential rental for ten years and claimed roughly $50,000 in depreciation over that period, that $50,000 slice of your profit is taxed at up to 25% regardless of your bracket. Only the gain above the depreciation amount qualifies for the lower long-term rates. The reasoning: depreciation reduced your ordinary income during ownership, and the government wants that benefit back at sale.
Appliances, carpeting, and other personal property inside a rental fall under Section 1245, not 1250. Any gain on those items up to the depreciation claimed is taxed as ordinary income at your full rate, not capped at 25%. This mainly matters if you did cost segregation work that shifted depreciation into shorter-life asset categories.
Net Investment Income Tax
Higher-income sellers face an extra 3.8% surtax on their gain. The net investment income tax applies to the lesser of your net investment income or the amount your modified adjusted gross income exceeds these thresholds:6Internal Revenue Service. Net Investment Income Tax
- $200,000 for single or head of household filers.
- $250,000 for married couples filing jointly.
- $125,000 for married filing separately.
These thresholds are not indexed for inflation and have not moved since the tax took effect in 2013.7Internal Revenue Service. Topic No. 559, Net Investment Income Tax The gain from selling an investment property counts as net investment income. A single seller with $180,000 in regular income who realizes a $100,000 gain has modified adjusted gross income of $280,000; the 3.8% applies to the $80,000 over the $200,000 threshold, roughly $3,040. Calculate it on Form 8960.
State Taxes
Federal is only part of the answer. Most states tax capital gains as ordinary income, with rates ranging from nothing to over 13% depending on where you live. About nine states have no personal income tax, and therefore no state capital gains tax. A handful offer partial exclusions or reduced rates on long-term gains. At the top end, California applies its full income tax rate to capital gains, which can push the combined federal and state rate above 50% for the highest earners. Check your state’s treatment before estimating net proceeds.
Deferring the Tax With a 1031 Exchange
A like-kind exchange under Section 1031 lets you roll the entire tax bill forward by reinvesting the sale proceeds into another investment property of equal or greater value.8Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment The capital gains, depreciation recapture, and net investment income tax all defer until you eventually sell the replacement in a taxable transaction. Some investors chain these exchanges for decades.
The deadlines are strict. After selling the relinquished property, you have 45 days to identify potential replacements in writing and 180 days to close on one of them.8Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment Miss either and the entire gain becomes taxable immediately. A qualified intermediary must hold the sale proceeds during the transition. Touch the cash at any point and the IRS treats it as constructive receipt, which kills the exchange.
Partial exchanges are allowed, but any shortfall triggers tax on the difference, called “boot.” Buy a replacement for less than you sold the old one for, or reduce your mortgage debt in the process, and the gap is taxable in the year of sale. Cash boot is simple: pull $30,000 out at closing and $30,000 is taxable. Mortgage boot is less obvious. If your old property had a $300,000 mortgage and the replacement carries a $200,000 loan, the $100,000 in debt relief is taxable even though no cash changes hands. Matching or exceeding both the sale price and the debt level avoids partial tax.
Installment Sales
If you finance part of the sale by carrying a note from the buyer, you can spread the capital gains tax over the years you receive payments rather than paying it all at once. The installment method applies automatically whenever at least one payment arrives after the close of the tax year of sale.9Office of the Law Revision Counsel. 26 U.S. Code 453 – Installment Method You can elect out and pay everything in year one if that suits you better.
One catch surprises a lot of sellers: depreciation recapture does not spread out. The full recapture amount is taxable in the year of the disposition, even if you will not see most of the payments until later.9Office of the Law Revision Counsel. 26 U.S. Code 453 – Installment Method Only the gain above the recapture amount follows the installment schedule. A seller who claimed $60,000 in depreciation and agreed to a five-year payout still owes recapture tax on that $60,000 in year one.
Releasing Suspended Passive Losses
Rental owners often carry passive losses they could not deduct in earlier years because passive activity rules limited them. Those suspended losses sit on your returns, sometimes for a decade or more. When you sell your entire interest in the property to an unrelated buyer in a fully taxable transaction, all of those losses are released at once and can offset the gain.10Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
Two conditions matter: you must dispose of your entire interest, and the buyer cannot be related to you. Meet both and your current-year losses and all prior-year unallowed losses become fully deductible against the sale proceeds.11Internal Revenue Service. Instructions for Form 8582 – Passive Activity Loss Limitations Under the installment method, released losses are allocated proportionally to the gain recognized each year rather than dumped into year one.
Inherited Property and Converted Homes
Two situations follow different rules from a straightforward investment sale.
If you inherited the property, your starting basis is generally the fair market value on the date the previous owner died, not what they originally paid.12Internal Revenue Service. Gifts and Inheritances This stepped-up basis can dramatically reduce or eliminate taxable gain. A parent’s rental bought for $120,000 decades ago that was worth $400,000 at death gives you a $400,000 basis; selling shortly after for $420,000 means $20,000 of gain, not $300,000.
If the property was your home before becoming a rental, you may still qualify for a partial Section 121 exclusion of up to $250,000 in gain ($500,000 for joint filers) if you owned and lived in it for at least two of the five years before sale.13Office of the Law Revision Counsel. 26 U.S. Code 121 – Exclusion of Gain From Sale of Principal Residence The exclusion shrinks for periods of nonqualified use, meaning the years the property served as a rental. The allocation is a ratio: rental years divided by total ownership years. Live in a home for five years and rent it for five, and roughly half the gain will not qualify. On top of that, depreciation you claimed or were entitled to claim after May 6, 1997, cannot be excluded regardless of whether you meet the ownership and use tests.14Internal Revenue Service. Sales, Trades, Exchanges That depreciation portion is taxed as recapture at up to 25%.
Paying Estimated Tax After the Sale
A large sale can create a tax bill that dwarfs your regular withholding. Without estimated payments to cover it, the IRS charges an underpayment penalty. You avoid the penalty by paying at least 90% of your current-year tax liability through withholding and estimated payments, or at least 100% of the prior year’s tax.15Internal Revenue Service. Estimated Taxes
Federal estimated payments are due April 15, June 15, and September 15 of the tax year, plus January 15 of the following year.16Internal Revenue Service. 2026 Form 1040-ES – Estimated Tax for Individuals Sell in July and you would typically make a payment by September 15 to cover the gain. You can also annualize your income to avoid overpaying in earlier quarters when the gain had not yet happened. The penalty is essentially interest on the amount you should have paid, so the longer you wait the more it costs.