Selling a Rental Property: Capital Gains and Depreciation Recapture

Selling a rental is different from selling a home you lived in. You may owe tax on the gain, and part of that gain can be taxed differently because of the depreciation you claimed while you owned it. Knowing how the pieces fit helps you decide when to sell and what to set aside. Tax rates, thresholds, and rules change often, so use this as an orientation and confirm current figures on IRS.gov or with a CPA before you list the property.

The basic idea: gain is price minus adjusted basis

Your taxable gain is roughly what you sold for, minus selling costs, minus your adjusted basis.

• Starting basis: generally what you paid, plus certain closing costs that are added to basis.
• Add: capital improvements, such as a new roof or an addition (see repairs vs. improvements for tax purposes).
• Subtract: depreciation you took, or were allowed to take, over the years.

The result is your adjusted basis. Because depreciation lowers basis, it raises your gain at sale. That is the trade for the deductions you enjoyed along the way. For how depreciation works, read rental property depreciation explained.

Short-term vs. long-term

How long you owned the property changes how the gain is taxed.

• Short-term: property held for one year or less is generally taxed at your ordinary income rates.
• Long-term: property held for more than one year generally qualifies for lower long-term capital gain rates.

If you are close to the one-year mark, the timing of the closing date can matter. The holding period details are in IRS guidance, so check the specifics for your situation.

Depreciation recapture

Gain attributable to depreciation is treated differently from the rest. In plain terms, the part of your gain that simply reverses the depreciation you claimed on the building is “recaptured” and taxed under special rules. For a residential rental placed in service after 1986 and held more than a year, the building is depreciated straight-line, so that part of the gain is usually unrecaptured section 1250 gain rather than ordinary income. The IRS says unrecaptured section 1250 gain is taxed at a maximum rate of 25% (Topic 409), which is higher than the top 20% long-term rate. Depreciation on personal property, such as appliances, including any bonus depreciation on it, is generally recaptured as ordinary income instead (Publication 544). The remaining gain, which comes from the property rising in value, is taxed as a regular long-term capital gain if you held it long enough.

Your basis is reduced by depreciation you were allowed to claim, even if you never claimed it, so the gain tied to that depreciation is still taxed. This is why skipping depreciation does not help.

A worked example

This is a hypothetical sale with round numbers. It illustrates the structure, not the tax you would owe. The purchase price includes the land; only the building portion was depreciated.

Now split the gain:

• $55,000 of it matches the depreciation you took, so it falls under the recapture rules. If it was all straight-line depreciation on the building, it is generally unrecaptured section 1250 gain, taxed at up to 25%.
• $62,000 is the remaining appreciation, generally taxed as long-term capital gain if you owned the property for more than a year.

Apply the current federal rates for each piece, which you can find on IRS.gov, then add any state tax and possible additional taxes that apply at higher incomes, such as the net investment income tax. A CPA can run this projection in a few minutes.

Ways to plan ahead

None of these are right for everyone, and each has rules and deadlines, so involve a professional early.

1. Like-kind exchange (Section 1031). For real property held for investment, a properly structured exchange can defer the tax by rolling the gain into a replacement property. Since 2018, it applies only to real property, not personal property such as appliances or furniture, and it is reported on Form 8824 (see the IRS like-kind exchange tax tips). The timelines are strict: per the Form 8824 instructions, you must identify replacement property in writing within 45 days after you transfer the property you are giving up, and receive it within 180 days or by the due date of your tax return (including extensions), whichever is earlier. Most deferred exchanges run through a qualified intermediary, and the instructions warn that a missed deadline can disqualify the exchange even if the intermediary caused it. Exchanges with related parties carry an extra two-year holding rule. You must set it up before closing, not after.
2. Installment sale. If you finance part of the sale yourself, you may be able to spread the gain over several years. IRS Publication 537 explains that any depreciation recapture income must be reported in full in the year of sale, and only the gain above it is spread out. How much of your gain counts as recapture income depends on the type of property and how it was depreciated; the publication’s own example of a straight-line building shows no depreciation recapture income. Ask a CPA to run the numbers.
3. Timing. Selling in a lower-income year, or after the one-year mark, may change the rate.
4. Offsetting losses. Capital losses on other investments can offset gains, subject to limits.
5. Holding. Some owners keep a property rather than sell. That is a financial choice with its own tradeoffs, so compare it with your cash flow and cap rate.

If the property was once your home, special home sale rules might reduce some of the gain, but depreciation taken after conversion and rental use can limit the benefit. These rules are detailed, so ask a CPA.

Reporting the sale

Sales of rental property are generally reported on Form 4797, with the results flowing to Schedule D or your main return as appropriate. IRS Publication 544, Sales and Other Dispositions of Assets, covers the details. Your annual rental reporting on Schedule E stops for that property after the sale, though the sale year may include rent and expenses up to the closing date. Your closing statement, improvement invoices, and depreciation schedule are the key documents, so keep them organized with your rental records.

Before you list

• Pull your depreciation schedule and improvement receipts.
• Confirm your land-versus-building allocation.
• Review lease end dates and notice rules for tenants in place, and plan for the security deposit return.
• Check whether an LLC or other ownership structure changes who reports the sale; see landlord LLC and legal structure.

Next steps

Gather your purchase closing statement, improvement invoices, and depreciation history, and calculate your approximate adjusted basis. Then ask a CPA for a sale-year tax projection and ask whether an exchange or installment sale makes sense. Run that after-tax figure against your other options, and only then set your asking price and timeline.

Related guides

• 1031 Exchange Basics for Rental Property Owners
• The Accidental Landlord: Inherited or Kept a House to Rent