Capital Gains Tax on Investment Property: Rates, Recapture, and Deferral

The capital gains tax on an investment property is calculated by subtracting your adjusted basis from the net sale price, then splitting the gain into two pieces taxed at different rates. The portion equal to the depreciation you claimed (or should have claimed) faces a federal rate of up to 25%. The rest is taxed at the long-term capital gains rates of 0%, 15%, or 20%, provided you held the property for more than a year. High earners may owe an additional 3.8% surtax on top.

How the Gain Is Calculated

The math runs in three steps. Start with the gross sale price and subtract selling expenses, such as the agent’s commission, advertising, legal fees, and closing costs you paid as the seller.1Internal Revenue Service. Publication 523 (2025), Selling Your Home That gives you the net sale price.

Next, subtract your adjusted basis. Basis starts with what you paid for the property, plus acquisition costs from closing (title fees, legal fees, recording fees, transfer taxes). Capital improvements you made over the years, such as a new roof, an added bathroom, or a replaced HVAC system, add to basis. Ordinary repairs and maintenance do not. Depreciation you deducted each year reduces basis. The result is your total realized gain.

Finally, split that gain. The piece tied to cumulative depreciation is taxed as unrecaptured Section 1250 gain at up to 25%. Whatever remains is your long-term capital gain, taxed at the preferential rates below.

Depreciation Recapture at 25%

The IRS requires you to depreciate the building (not the land) of a rental over its useful life. For residential rental property, that period is 27.5 years using the straight-line method.2Internal Revenue Service. Publication 527 (2025), Residential Rental Property For commercial property, the period is 39 years.3Internal Revenue Service. Publication 946 (2025), How To Depreciate Property

When you sell, the IRS carves out the portion of the gain equal to your total depreciation and taxes it separately at a maximum federal rate of 25%.4Internal Revenue Service. Treasury Decision 8836 – Unrecaptured Section 1250 Gain Recapture applies to the lesser of your total depreciation deductions or your total realized gain.

An example makes this concrete. You bought a rental for $300,000, claimed $60,000 of depreciation over the years, and sell at a gain of $120,000. The first $60,000 of that gain is taxed at up to 25% as recapture, potentially costing $15,000. The remaining $60,000 is taxed at your long-term capital gains rate.

If your gain is smaller than your accumulated depreciation, the entire gain is recapture at 25%. None of it reaches the lower long-term brackets. This happens more often than sellers expect on properties that appreciated slowly but sat in service for many years.

One trap to know about: recapture is based on depreciation “allowed or allowable.”3Internal Revenue Service. Publication 946 (2025), How To Depreciate Property Skipping depreciation deductions on your annual returns does not save you from the recapture bill. The IRS calculates it as though you had taken every dollar you were entitled to.

2026 Long-Term Capital Gains Rates

The portion of the gain that exceeds your accumulated depreciation is taxed at 0%, 15%, or 20%, based on your total taxable income for the year (not just the gain from this sale). For 2026:5Internal Revenue Service. Revenue Procedure 2025-32

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

Most investment property sellers land in the 15% bracket. The 0% rate almost never applies to a year with a large property sale, because the sale itself typically pushes taxable income above the threshold. Sellers who reach the 20% rate are usually also subject to the 3.8% surtax, which brings the effective federal rate on that portion to 23.8%.

Short-Term Sales and the Dealer Boundary

Two situations knock a sale out of the preferential rates entirely. If you owned the property for one year or less, the entire gain is short-term and taxed at your ordinary income rate, which reaches 37% in 2026.6Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 The one-year threshold is a bright line worth waiting past before closing.

Separately, if the IRS treats you as a dealer or flipper rather than an investor, the profit is ordinary business income at your full marginal rate. Capital gains treatment is only available for property held for investment or rental, not property held primarily for resale as a trade.

The 3.8% Net Investment Income Tax

Higher-income sellers owe an additional 3.8% surtax on net investment income, which includes capital gains from a property sale. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds a fixed threshold: $200,000 for single filers, $250,000 for married filing jointly.7Internal Revenue Service. Net Investment Income Tax These thresholds are not adjusted for inflation.8Internal Revenue Service. Questions and Answers on the Net Investment Income Tax

Take a married couple with $400,000 in MAGI and a $200,000 gain from a rental sale. The NIIT applies to the lesser of $200,000 in investment income or $150,000 in excess MAGI. The surtax is 3.8% of $150,000, or $5,700, on top of the capital gains tax and recapture.

Selling at a Loss

If the net sale price falls below your adjusted basis, you have a loss. Rental property held more than a year and used in a trade or business generally qualifies as Section 1231 property.9Office of the Law Revision Counsel. 26 U.S. Code 1231 – Property Used in the Trade or Business That classification produces a favorable asymmetry: net Section 1231 gains get long-term capital gains rates, but net Section 1231 losses are treated as ordinary losses. Ordinary losses can offset wages and other income without the $3,000 annual cap that applies to capital losses.

Losses that stay in the capital category first offset capital gains from other sales in the same year. Short-term losses offset short-term gains first, long-term losses offset long-term gains first, and anything left crosses over. If you still have a net loss after that netting, you can deduct up to $3,000 per year ($1,500 if married filing separately) against ordinary income, and carry the rest forward indefinitely.10Internal Revenue Service. Topic No. 409, Capital Gains and Losses

Ways to Defer or Reduce the Tax

1031 Like-Kind Exchange

A Section 1031 exchange lets you swap one investment property for another and defer both the capital gains tax and the depreciation recapture. The deferred tax rolls into the replacement property’s basis until you sell that property in a taxable transaction.11Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031

Two deadlines govern the exchange and both start on the day you close the sale of the original property. You must identify replacement candidates in writing within 45 calendar days. You must close on the replacement within 180 calendar days, or by the due date (with extensions) of your tax return for the year of sale, whichever comes first. Missing either deadline kills the exchange and the full gain becomes immediately taxable.

The replacement must equal or exceed the property you gave up in value, equity, and debt. Any shortfall creates “boot,” which is taxable. You also cannot touch the proceeds between sales: a qualified intermediary must hold the funds, and neither you nor any professional who has worked for you in the past two years can serve that role.

Converting to a Primary Residence

Homeowners who sell a primary residence can exclude up to $250,000 of gain ($500,000 for married couples filing jointly) if they owned and lived in the home for at least two of the five years before the sale.1Internal Revenue Service. Publication 523 (2025), Selling Your Home Some investors try to capture this by moving into a former rental before selling.

The strategy works only partially. A non-qualified use rule allocates the gain between the rental period and the residence period, and only the residence portion qualifies for the exclusion. Depreciation recapture is never eligible for the exclusion, no matter how long you lived there.

Installment Sale

If you agree to receive payments over multiple tax years rather than a lump sum, the installment method spreads gain recognition across the years payments arrive.12Internal Revenue Service. Publication 537 (2025), Installment Sales Each payment breaks into three pieces: return of basis (tax-free), gain (taxable at capital gains rates), and interest (taxable as ordinary income). This can keep more of the gain in a lower bracket in any single year. You report installment income on Form 6252.

Paying and Reporting the Tax

A large gain can create an estimated tax obligation that catches sellers off guard. If you expect to owe at least $1,000 after withholding and credits, and your withholding will not cover 90% of the current year’s tax or 100% of the prior year’s tax (110% if your prior-year AGI exceeded $150,000), you generally need to make an estimated payment for the quarter of the sale.13Internal Revenue Service. Large Gains, Lump Sum Distributions, Etc. You can annualize your income for that quarter using the worksheet in Publication 505, then file Form 2210 with Schedule AI to show the uneven payment matched your uneven income.

Several forms handle the reporting:

State income tax adds another layer. Most states tax capital gains, with rates ranging from zero in states with no income tax to above 10% in the highest-rate states. Combined with the federal calculation, recapture, and possible surtax, the total bill on a property sale can be substantially higher than the federal figure alone.