Capital Gains Tax on Rental Property: What Landlords Should Understand Before Selling

Short answer:

When you sell a rental property for more than your adjusted basis, you may owe tax on the gain. That does not mean tax is based simply on the sale price minus what you originally paid. Rental property tax depends on adjusted basis, capital improvements, depreciation allowed or allowable, selling costs, debt, state taxes, and sometimes the 3.8% Net Investment Income Tax.

For 2026, federal long-term capital gains brackets are generally 0%, 15%, or 20% depending on taxable income, but rental property can also involve unrecaptured Section 1250 gain tied to depreciation, which may be taxed at a maximum 25% rate. Talk to a CPA before listing, not after accepting an offer.

Who this is for

This is for rental property owners who are thinking about selling and want a plain-English view of what taxes may show up. It is especially relevant if you have owned the property for a long time, depreciated it, improved it, refinanced it, or converted it from a home to a rental.

Why this matters

The tax bill can change the entire sale decision. A property that looks like a clean exit may be less attractive after federal tax, state tax, depreciation recapture, NIIT, and reinvestment needs.

This does not mean you should avoid selling. It means you should not sell blind.

The basic idea

Capital gain is generally the amount realized from the sale minus your adjusted basis. For a rental property, adjusted basis is not just the original purchase price. It can be affected by improvements and depreciation.

The IRS says rental property owners generally reduce basis by depreciation deductions allowed or allowable. That phrase matters. Even if an owner did not claim depreciation correctly, the tax calculation may still require a basis reduction for depreciation that was allowable.

Example

A landlord bought a rental for $350,000. Over the years, the owner made $100,000 of capital improvements. The owner also claimed depreciation, or was allowed to claim depreciation, over the holding period. The property later sells for $950,000.

The gain is not simply $950,000 minus $350,000. A CPA needs to look at adjusted basis, land/building allocation, improvements, depreciation, closing costs, selling expenses, and state rules. If the owner skips that step, the net proceeds can be badly misunderstood.

Taxes that may matter

• Federal long-term capital gains tax: The IRS lists 0%, 15%, and 20% capital gains brackets depending on taxable income and filing status.
• Unrecaptured Section 1250 gain: The IRS notes that gain attributable to depreciation on certain real property may be taxed at a maximum 25% rate.
• Net Investment Income Tax: The IRS states that a 3.8% NIIT may apply to certain net investment income above threshold amounts.
• State and local taxes: These vary by state and sometimes locality.
• Tax on boot in a 1031 exchange: Cash or other non-like-kind property received in an exchange can create taxable gain.

Tradeoffs to understand

A cash sale gives flexibility. It can also make the tax bill immediate.

A 1031 exchange may defer some or all gain if done correctly. But it adds timing pressure and requires qualifying replacement property. It may be a good tool in the right facts. It is not a magic eraser.

Holding until death can change basis for heirs in many cases, but that is an estate and family decision, not just a tax move. It may preserve tax benefits while preserving management headaches, family conflict, property risk, or deferred maintenance.

Do not calculate this from memory

Many landlords know what they paid for the property. That is useful, but it is not enough. The tax calculation can depend on records that may be sitting in old returns, depreciation schedules, closing statements, contractor invoices, and refinance files.

A landlord who guesses basis from memory can be directionally wrong by a lot. The property may have decades of depreciation. Improvements may increase basis. Prior exchanges may carry old basis into the current property. The cleaner move is to gather records and have a CPA build the estimate.

What to bring to the CPA

• Original settlement statement from purchase, if available.
• Most recent depreciation schedule.
• Records of major capital improvements.
• Prior 1031 exchange documents, if any.
• Current loan payoff estimate.
• Estimated broker fees and selling costs.
• Expected sale price range.
• State of residency and property location.

The CPA does not need a perfect sale price to start. A range is enough for planning.

Common mistakes

• Using original purchase price instead of adjusted basis.
• Forgetting depreciation recapture.
• Assuming the primary-residence exclusion applies to a rental property.
• Ignoring state taxes.
• Assuming debt payoff reduces taxable gain by itself.
• Waiting until after signing a sale contract to ask a CPA about a 1031 exchange.
• Not keeping records of improvements and depreciation schedules.

Questions to ask before selling

Questions for your CPA

• What is my adjusted basis?
• How much depreciation was allowed or allowable?
• What may be taxed as capital gain?
• What may be unrecaptured Section 1250 gain?
• Could NIIT apply?
• What state taxes should I plan for?
• Would a 1031 exchange change the answer?

Questions for your attorney

• Is title clean?
• Is the ownership entity correct?
• Are there lease, estate, or family-ownership issues before sale?

Questions for your broker

• What net proceeds estimate should we build around?
• What costs are likely at closing?
• Could timing affect tax planning?

Questions for your financial adviser

• How should after-tax proceeds be used?
• How much income do I need?
• Should I hold more liquidity after selling?

How Hatch can help

Hatch can help organize the conversation before a sale gets too far ahead of the tax plan. Hatch does not calculate your tax bill or provide tax advice. The goal is to make sure you know which questions to bring to the right professionals before the decision gets compressed.