Two Types of Gain on Rental Property Sale
When you sell a rental property, your total gain is split into two components with different tax rates: depreciation recapture gain (taxed at a maximum 25% rate) and long-term capital gains on the remaining appreciation (taxed at 0%, 15%, or 20%). Understanding the split is essential for accurate tax calculation.
Capital gains components on rental property sale
| Component | Tax Rate | What It Covers |
|---|---|---|
| Depreciation recapture (Section 1250) | Maximum 25% | All depreciation claimed or could have been claimed during ownership |
| Long-term capital gain (Section 1231) | 0%, 15%, or 20% | Appreciation above original purchase price (minus land) |
| Unrecaptured Section 1250 gain | Maximum 25% | The portion of the Section 1231 gain equal to prior depreciation |
| State capital gains tax | Varies (same as ordinary income in most states) | Applies to total gain after federal calculation |
How Depreciation Recapture Works
When you own rental property, you claim annual depreciation deductions — typically the cost of the building (not land) divided by 27.5 years. These deductions reduce your taxable rental income each year. When you sell, the IRS recaptures all depreciation claimed, taxing it at a maximum 25% rate. This applies even if you forgot to claim depreciation.
Purchased rental property for $300,000 ($250K building, $50K land) in 2015. Annual depreciation: $9,091. After 10 years: $90,910 in total depreciation claimed. Adjusted basis: $300,000 - $90,910 = $209,090. Sold in 2025 for $450,000. Total gain: $450,000 - $209,090 = $240,910. Depreciation recapture gain: $90,910 (taxed at max 25%). Remaining LTCG: $150,000 (taxed at 15-20%).
The 1031 Exchange: Deferring All Capital Gains Tax
A Section 1031 like-kind exchange allows you to defer all capital gains tax (including depreciation recapture) by rolling your proceeds into another qualifying investment property. You must: identify the replacement property within 45 days of sale, and close on the replacement within 180 days. The exchange must use a qualified intermediary — you cannot touch the proceeds yourself.
- 45-day identification rule: Must identify up to 3 potential replacement properties within 45 days
- 180-day closing rule: Must close on the replacement property within 180 days of the original sale
- Equal or greater value: To defer all gain, replacement must be equal or greater in value than sold property
- All equity must be reinvested: Any cash you receive ('boot') is taxable
- Qualified intermediary required: Cannot personally receive sale proceeds during the exchange
- Only works for investment/business property: Primary residence does not qualify
- No limit on number of exchanges: You can chain 1031 exchanges indefinitely, with basis tracking throughout
Net Investment Income Tax on Rental Property Sales
Rental property capital gains are generally subject to the 3.8% Net Investment Income Tax if your MAGI exceeds $200,000 (single) or $250,000 (MFJ), unless the rental is considered an active trade or business. Most residential rentals are passive investments, making the gain NIIT-subject. Real estate professionals (those spending 750+ hours in real estate activities annually) may qualify for the active trade or business exception.
Calculate Your Rental Property Capital Gains Tax
Enter your purchase price, total depreciation claimed, sale price, and income to see your complete tax breakdown.