What Expenses Are Deductible When Selling a Rental Property?

When you sell a rental property, the deductible expenses that reduce your taxable gain fall into three groups: the costs you pay to close the sale, the capital improvements you made during ownership, and any suspended passive losses released by the disposition. The IRS treats a rental as business or investment property, so the sale produces a gain or loss measured against your adjusted basis rather than a simple profit figure.¹ Getting each category right can change your tax bill by tens of thousands of dollars.

Selling Costs That Come Off the Sale Price

Direct costs of closing the transaction are subtracted from the gross sale price to arrive at your “amount realized,” the number the IRS actually uses to measure gain. Every dollar spent to complete the sale is a dollar that never appears as profit.

Real estate commissions. Agent fees have traditionally run about 5 to 6 percent of the sale price, though industry changes following the 2024 NAR settlement have pushed many sellers toward negotiated rates.²
Legal and title fees. Attorney fees for contract review, title searches, title insurance premiums, and seller-paid escrow or settlement charges.
Transfer taxes. State and local transfer taxes on the sale, which range from a fraction of a percent to well over one percent of the sale price depending on jurisdiction.
Marketing and advertising. Professional photography, listing fees, and staging costs that do not physically alter the property.
Seller-paid points. Points paid to the buyer’s lender as part of the deal are treated as a selling expense that reduces your amount realized.³

All of these show up on your closing statement (sometimes called the settlement statement or Closing Disclosure). That document is your primary record for substantiating the deductions, so keep it with your tax files.

Mortgage Prepayment Penalties

If your lender charges an early payoff penalty at closing, that penalty is generally deductible as mortgage interest rather than as a selling expense.³ It still reduces your tax bill, but it lands on a different line of your return than the closing costs above.

Capital Improvements Added to Your Basis

Your adjusted basis is the yardstick the IRS uses to measure gain or loss. It starts with what you originally paid for the property, including acquisition costs like title insurance, recording fees, and transfer taxes paid at purchase, then gets adjusted up or down over the years you own it.⁴ Capital improvements push the basis higher, which shrinks the eventual gain.

A capital improvement is any project that adds value, extends the property’s useful life, or adapts it to a new purpose. Replacing the roof, installing a new HVAC system, adding a deck, or gutting the kitchen all qualify. These costs are not deducted in the year you spend them. They get added to basis instead. A $20,000 kitchen renovation done five years before the sale reduces your taxable profit by $20,000, minus any depreciation you claimed on it in the meantime.

Routine repairs are different. Fixing a leaky faucet, repainting a room, or patching drywall keeps the property functional but does not increase its value or lifespan. Those are operating expenses you deducted on Schedule E in the year you paid them. They do not touch basis. The line sometimes blurs, but the test is whether the work made the property better, longer-lasting, or suited for a different use, versus simply restoring it to its existing condition.

This is where meticulous records pay off. Every receipt and invoice for capital work done during ownership directly reduces the gain you report. Sellers with sloppy records lose those deductions entirely because they cannot prove the expenditures. A spreadsheet updated after each project, paired with contractor invoices, is worth far more at sale time than most owners realize.

Depreciation Reduces Basis Before the Sale

Capital improvements raise basis, but depreciation pulls it back down, and this is the surprise most rental sellers do not see coming. Residential rental property is depreciated over 27.5 years, and the IRS expects you to claim that deduction every year you rent the property out.⁵ Each year of depreciation reduces your adjusted basis. When you sell, the IRS recaptures that benefit by taxing the total depreciation amount, whether you actually claimed it or not. The tax code uses the phrase “allowed or allowable,” meaning if you forgot to take the deduction, you still owe recapture tax as though you had.

The recapture portion of your gain is taxed at ordinary income rates, capped at 25 percent.⁶ Any gain above the depreciation amount gets taxed at the lower long-term capital gains rates, assuming you held the property more than a year.

A simplified example. You bought a rental for $300,000, with $60,000 allocated to land (not depreciable) and $240,000 to the building. After 10 years, you have claimed about $87,273 in depreciation ($240,000 ÷ 27.5 × 10). Your adjusted basis is now roughly $212,727. Sell for $375,000 with $25,000 in selling costs, and your amount realized is $350,000. The total gain is $137,273. Of that, $87,273 is taxed at the recapture rate (up to 25 percent), and the remaining $50,000 is taxed at the capital gains rate. On a property held a decade or more, the recapture chunk is often larger than sellers expect.

Suspended Passive Losses Released at Sale

If you had rental losses over the years that exceeded what the passive activity rules allowed you to deduct, those losses did not disappear. They have been accumulating as suspended passive losses. Selling the entire property in a fully taxable transaction to an unrelated buyer unlocks all of them at once.⁷

This can be a significant benefit. Say you accumulated $30,000 in suspended losses over several years because your adjusted gross income exceeded $150,000 and the $25,000 rental loss allowance phased out. When you sell, those $30,000 become fully deductible and offset the gain from the sale, or even other income on your return. The requirement is that you dispose of your entire interest in the activity to an unrelated person. Selling a partial interest or transferring to a related party does not trigger the release.

If you sell using the installment method, the released losses are proportioned based on how much gain you recognize each year rather than being freed up all at once.⁷ For a straightforward closing, the full amount becomes available in the year of the sale.

Deferral Is Not a Deduction: The 1031 Option

If you would rather not pay tax on the gain at all right now, a Section 1031 like-kind exchange lets you defer the entire gain, including depreciation recapture, by reinvesting the proceeds into another investment or business property.⁸ The tax is postponed, not eliminated: the deferred gain carries into the replacement property’s basis. Strict deadlines apply (45 days to identify a replacement, 180 days to close), and a qualified intermediary must hold the proceeds. Property held primarily for resale does not qualify. This is a separate path from the deductions covered above and requires planning before you close, not after.

Reporting the Sale and Proving the Deductions

You will typically need three forms. Form 4797 handles the sale of business property, including depreciation recapture.¹ Schedule D captures the capital gain or loss. If you had suspended passive losses, Form 8582 documents their release.⁷ The closing agent will also send you a Form 1099-S reporting the gross proceeds. Unlike sales of a principal residence, there is no exemption from that reporting for rental properties, so expect one.⁹

Records to Gather Before You File

Original closing statement. Your HUD-1 or Closing Disclosure from the purchase, which establishes your starting basis including acquisition costs.⁵
Capital improvement records. Receipts and invoices for every improvement made during ownership, with dates.
Depreciation schedules. Your prior returns showing the depreciation claimed or allowable each year.
Current sale closing statement. The final settlement document listing the price and all selling expenses.
Form 1099-S. The gross proceeds report sent by the closing agent.

How Long to Keep Everything

Keep property records until the statute of limitations expires for the year you dispose of the property. That generally means at least three years after filing the return that reports the sale, and six years if you underreport income by more than 25 percent. If you roll into a 1031 exchange, keep records from both the old and new properties until the limitations period runs on the year you eventually sell without exchanging again.¹⁰ Seven years gives most sellers a comfortable margin.

1
Internal Revenue Service. Sale or Trade of Business, Depreciation, Rentals
2
Board of Governors of the Federal Reserve System. Commissions and Omissions: Trends in Real Estate Broker Compensation
3
Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction
4
Office of the Law Revision Counsel. 26 USC 1011 – Adjusted Basis for Determining Gain or Loss
5
Internal Revenue Service. Publication 527 (2025), Residential Rental Property
6
Internal Revenue Service. Publication 946 (2024), How To Depreciate Property
7
Internal Revenue Service. 2025 Instructions for Form 8582 – Passive Activity Loss Limitations
8
Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
9
Internal Revenue Service. Instructions for Form 1099-S Proceeds From Real Estate Transactions
10
Internal Revenue Service. How Long Should I Keep Records?