Taxes on Selling a Rental House: Rates, Recapture, and Deferrals

Selling a rental house can trigger up to three layers of federal tax: depreciation recapture at a rate of up to 25% on the portion of the gain tied to depreciation you took or should have taken, long-term capital gains tax at 0%, 15%, or 20% on the remaining appreciation, and a 3.8% net investment income surtax if your income clears certain thresholds. The taxes on selling a rental house depend on how long you owned it, how much depreciation piled up, your other income for the year, and whether you use one of the tax code’s deferral tools. The starting point is not the price you paid versus the price you sold for; it is your adjusted basis, and that number does most of the work.

How the Gain Is Calculated

Your taxable gain is the difference between your net sale price and your adjusted basis. The adjusted basis is where sellers underestimate their bill, because depreciation quietly lowers it every year you own the property.

Cost Basis, Improvements, and Depreciation

Start with what you paid, including the down payment and any debt used to finance the purchase. Add the closing costs from the original acquisition: title insurance, legal fees, recording charges, survey fees. If you bought land and building together, split the price between them, because land is not depreciable; relative fair market values work, and property tax assessed values are a reasonable proxy if you have no appraisal.¹

If you inherited the property, your starting basis is generally the fair market value on the date of the previous owner’s death, not what they paid.² This stepped-up basis can erase decades of appreciation from the tax ledger.

Capital improvements raise your basis. A new roof, a kitchen remodel, an added bedroom, central air — these get added on and later reduce your gain.³ Ordinary repairs like patching drywall or fixing a faucet do not; you deducted those in the year you paid, and they do nothing for you at sale.

Depreciation cuts the other direction. Residential rental buildings depreciate over 27.5 years straight-line under MACRS, and each year’s depreciation reduces your basis by the same amount.⁴ Here is the trap: even if you never claimed the deduction, the IRS still reduces your basis by the amount you were entitled to claim. That is the “allowed or allowable” rule, and it means skipping depreciation during ownership does not save you from recapture at sale.⁵

Your Net Sale Price

From the sale price, subtract selling expenses: real estate commissions, legal fees, title insurance, advertising, transfer taxes the seller pays, and other closing costs. What remains is your amount realized.

A Worked Example

You bought a rental for $400,000. You claimed $100,000 in depreciation over the years and put in $20,000 of capital improvements. Your adjusted basis is $320,000. You sell for a net price of $600,000 after commissions and closing costs. Your total gain is $280,000. Of that, $100,000 matches your accumulated depreciation and gets taxed at the recapture rate; the other $180,000 is appreciation taxed at long-term capital gains rates.

The Three Federal Rates

The gain splits into pieces that face different rates. This is why a rental sale rarely reduces to a single clean percentage.

Depreciation Recapture at Up to 25%

The portion of your gain equal to the depreciation you took or should have taken is called unrecaptured Section 1250 gain and faces a federal rate capped at 25%.⁶ If your ordinary bracket is lower than 25%, the recapture is taxed at that lower rate. For most investors selling an appreciated property, though, 25% is the effective ceiling.

Recapture is limited to the lesser of your total gain or your accumulated depreciation. If your gain is smaller than your total depreciation, the entire gain is recapture and none of it reaches the capital gains rate.

Long-Term Capital Gains on the Appreciation

Whatever gain remains after recapture is taxed at long-term capital gains rates, provided you held the property more than a year. For 2026 the brackets are:

0% on taxable income up to $49,450 for single filers, $98,900 for married filing jointly
15% up to $545,500 (single) or $613,700 (joint)
20% above those amounts

The thresholds adjust for inflation each year.⁷ The gain stacks on top of your other income, so a large sale can push the top slice of your appreciation gain into the 20% tier even if your salary alone would not reach it.

The 3.8% Net Investment Income Tax

The NIIT adds 3.8% on top of the capital gains rate for taxpayers whose modified adjusted gross income clears $200,000 single or $250,000 joint. Both the recapture and the appreciation from a rental sale count as net investment income. The 3.8% applies to the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.⁸ These thresholds are not indexed for inflation and have stayed the same since 2013.⁹

At the top end, the combined rate on recapture can reach 28.8% and on appreciation 23.8%.

Holding for a Year or Less

If you owned the rental for one year or less, the whole gain is short-term and taxed at ordinary rates, which reach 37% at the top.⁷ The 25% recapture ceiling and the long-term capital gains rates do not apply. The NIIT can still stack on top.

Ways to Defer or Reduce What You Owe

Several tools in the code let you defer, spread, or partially exclude the gain. Each has strict deadlines and specific conditions, and missing a step usually collapses the benefit entirely.

1031 Like-Kind Exchange

A like-kind exchange lets you roll the proceeds into a replacement investment property and defer both the capital gains tax and the depreciation recapture. The replacement must be real property held for investment or business use, but the flexibility is wide: you can exchange a single-family rental for an apartment building, commercial space, or vacant land.¹⁰

Two deadlines are absolute. You have 45 days from your sale’s closing to identify replacement properties in writing, and 180 days from that same date to close on the replacement.¹⁰ A Qualified Intermediary must hold the sale proceeds throughout; if the money touches your account, the deferral is lost.¹¹

The tax is deferred, not forgiven. Your replacement inherits a reduced basis carrying the old gain forward. Sell the replacement in a taxable transaction later and the accumulated gain comes due. Investors sometimes chain exchanges for decades and let the stepped-up basis at death clear the ledger for their heirs.

Moving In and Using the Section 121 Exclusion

Convert the rental into your primary home and you may be able to exclude up to $250,000 of appreciation gain, or $500,000 for a married couple filing jointly. You must have owned the property and lived in it as your principal residence for at least two of the five years before the sale.¹²

Two limits catch former landlords by surprise. First, the exclusion is reduced by any period of “nonqualified use” after December 31, 2008. If you rented the property for four years after 2008 and then lived in it for two, only two-sixths of the appreciation qualifies. Second, the exclusion never applies to depreciation recapture. Gain equal to depreciation taken after May 6, 1997, is still taxed at up to 25%, no matter how long you live there.¹²

Installment Sale

If you finance part of the sale yourself with a seller-carried note, the installment method spreads the capital gains tax across the years you receive payments. Each year you recognize a share of the gain proportional to the payments received.¹³

Depreciation recapture cannot be spread. The full recapture amount is taxed in the year of sale regardless of how little cash you actually receive that year.¹⁴ If your property carries significant accumulated depreciation, expect a real bill in year one even without much cash at closing.

Suspended Passive Activity Losses

If your rental generated losses in earlier years that you could not deduct because of the passive activity rules, those suspended losses are released when you sell your entire interest in the activity to an unrelated buyer in a fully taxable transaction. The accumulated losses offset the gain directly.¹⁵

Sellers overlook this often. If $40,000 in suspended losses sat on your Form 8582 across years of ownership, they knock $40,000 off the gain you report. Selling a partial interest or transferring to a related party does not trigger the release.¹⁶ Check your prior returns before you close.

Qualified Opportunity Zone Funds

You can defer the gain by investing the gain amount into a Qualified Opportunity Fund within 180 days of the sale. Both standard capital gains and Section 1231 gains qualify, and the investment must be equity in the fund, not a loan.¹⁷

The window is closing. The deferred gain must be recognized no later than December 31, 2026, whether or not you have sold the fund investment by then.¹⁸ The larger basis step-ups that made the program attractive earlier required much longer holding periods, so at this point the deferral is short and the forced recognition date is close.

Selling at a Loss

Rental property qualifies as Section 1231 property. Gains get favorable capital gains rates, but losses are ordinary losses that offset your regular income without the $3,000 annual cap that applies to capital losses.¹⁹ The asymmetry favors the seller.

One warning: because depreciation lowers your basis year after year, many properties that sell below their original purchase price still produce a taxable gain. Run the adjusted basis number before assuming a loss.

What You File and Report

The settlement agent or closing attorney files Form 1099-S with the IRS reporting your gross sale proceeds, and you get a copy.²⁰ Check the amount against your closing statement — it should be the gross sale price before commissions and costs — and get any error fixed, because the IRS matches this form to your return.

Form 4797 is where the sale itself is reported. It calculates the unrecaptured Section 1250 gain in Part III and passes the net Section 1231 gain to Schedule D.¹⁹ If the sale is at a loss, Form 4797 handles the ordinary loss too.

Schedule D pulls the long-term appreciation portion in, combines it with other capital gains and losses, applies the tier rates, and passes the result to Form 1040.²¹ If you released suspended passive losses on the sale, you also file Form 8582 to document them.¹⁶

State Taxes and Foreign Seller Withholding

Federal is only part of the bill. Most states with an income tax also tax capital gains, typically at the same rate as ordinary income. State rates on a rental sale range from zero in about nine states to roughly 13% or higher at the top. Some jurisdictions add transfer taxes or deed stamps at closing that range from nominal flat fees to several percent of the sale price. Check your state’s rules before estimating your after-tax proceeds.

If you are a non-resident alien or foreign corporation selling U.S. rental property, the buyer must withhold 15% of the gross sale price at closing under the Foreign Investment in Real Property Tax Act.²² The withholding is a deposit against your actual federal tax, not the final tax. You reconcile it on your U.S. return for the year of sale and can claim a refund if it exceeds the real liability, or apply in advance for a reduced amount by filing Form 8288-B before closing.²³

1
Internal Revenue Service. Publication 551, Basis of Assets
2
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
3
Internal Revenue Service. Publication 527, Residential Rental Property
4
Internal Revenue Service. Publication 527, Residential Rental Property – Section: Depreciation of Rental Property
5
Internal Revenue Service. Publication 946, How To Depreciate Property – Section: Adjusted Basis
6
Office of the Law Revision Counsel. 26 USC 1(h) – Tax Imposed
7
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
8
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
9
Congressional Research Service. The 3.8% Net Investment Income Tax – Overview, Data, and Policy Options
10
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
11
eCFR. 26 CFR 1.1031(k)-1 – Treatment of Deferred Exchanges
12
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
13
Office of the Law Revision Counsel. 26 USC 453 – Installment Method
14
Internal Revenue Service. Publication 537, Installment Sales
15
Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules
16
Internal Revenue Service. 2025 Instructions for Form 8582
17
Internal Revenue Service. Invest in a Qualified Opportunity Fund
18
Internal Revenue Service. Opportunity Zones Frequently Asked Questions
19
Internal Revenue Service. Instructions for Form 4797, Sales of Business Property
20
Internal Revenue Service. Instructions for Form 1099-S
21
Internal Revenue Service. 2025 Instructions for Schedule D (Form 1040)
22
Internal Revenue Service. FIRPTA Withholding
23
Internal Revenue Service. Format for Applications