Capital Gains Tax on Investment Property: What You Owe

Your taxable gain on a rental or other investment property is the sale price minus selling costs, minus your adjusted basis, which is what you paid plus improvements, minus depreciation. If you held the property more than a year, the part of the gain equal to the building's depreciation (or the whole gain, if that is smaller) is taxed at your ordinary rate but no more than 25%, and the rest at 0%, 15%, or 20% depending on your 2026 taxable income. The 3.8% net investment income tax can apply on top once modified adjusted gross income (MAGI) passes $200,000, or $250,000 for married couples filing jointly, and property held one year or less is taxed entirely at ordinary rates of up to 37%.

How to figure your gain

1. Amount realized: the sale price, counting any of your debts the buyer takes over as part of the price, minus selling expenses such as commissions and seller-paid closing costs.
2. Adjusted basis: your purchase price plus buying costs that go into basis (title insurance, recording fees, transfer taxes, legal fees), plus capital improvements such as a new roof, minus all depreciation you claimed or were entitled to claim. Loan costs such as points and lender-required appraisals are not part of basis.
3. Gain: amount realized minus adjusted basis.

Depreciation reduces your basis even for years you did not claim it, so skipping the deduction does not lower the tax at sale.

Example: a married couple filing jointly bought a rental house for $300,000 including closing costs, later added a $20,000 roof, and claimed $90,000 of depreciation over the years. In 2026 they sell for $520,000 and pay $30,000 in commissions and other selling costs.

• Amount realized: $520,000 minus $30,000 = $490,000
• Adjusted basis: $300,000 plus $20,000 minus $90,000 = $230,000
• Gain: $490,000 minus $230,000 = $260,000

In this sale the gain on the building alone is more than its $90,000 of depreciation, so that $90,000 is what the IRS calls unrecaptured Section 1250 gain, the part capped at 25%. The other $170,000 is long-term capital gain. If part of the price is for appliances, carpet, or furniture you depreciated, gain on those items up to their depreciation is ordinary income instead; depreciation recapture explains both kinds of recapture and how to fix missed depreciation before you sell.

The rate on each part of the gain in 2026

Long-term capital gain rates depend on taxable income, including the gain:

The depreciation part is taxed at your regular bracket rates, stacked on top of your other income, with a 25% ceiling. The 3.8% net investment income tax applies to the smaller of your net investment income, which includes gain on investment real estate, or the amount by which MAGI exceeds $200,000 for single and head of household filers, $250,000 for joint filers, or $125,000 for married filing separately. Those thresholds are not adjusted for inflation.

Continuing the example, the couple has $182,200 of wages and takes the $32,200 standard deduction, leaving $150,000 of taxable income before the sale. With the gain, their MAGI is $442,200:

That is about 20.5% of the $260,000 gain, before any state income tax. If they had owned the property one year or less, the whole gain would be taxed at ordinary rates; short-term capital gains on real estate covers that case. The holding period starts the day after you acquire the property and includes the day you sell.

What happens if you sell at a loss

Rental property held more than a year is what the tax code calls Section 1231 property, meaning business and rental property held long term. If your gains and losses on that kind of property for the year net to a loss, the loss is ordinary: it is deductible against wages and other income without the $3,000 annual limit on capital losses. Two rules can change that result:

• Former home turned rental: your basis for figuring a loss starts at the lower of your adjusted basis or the property's fair market value on the day you began renting it, so a drop in value before the conversion is not deductible.
• Five-year lookback: after a net loss on business and rental property, net gains on that kind of property in the next five years are taxed as ordinary income up to the amount of the loss.

Suspended passive losses are released in the sale year

If the property has passive losses that could not be deducted in earlier years, selling your entire interest to an unrelated buyer in a fully taxable sale makes all of them, and the current year's rental loss, deductible that year against any income. A 1031 exchange or a sale to a related person, such as a family member, does not release them in full. Passive loss rules for real estate investors covers how those losses carry forward and the other ways they are released.

Reporting the sale on Form 4797 and Schedule D

1. The closing agent generally reports the sale to the IRS on Form 1099-S.
2. Form 4797 figures the gain on the building and the land separately and pulls out any ordinary-income recapture, such as on appliances. The rest of a gain on property held more than a year carries to Schedule D as long-term capital gain, and a net loss is treated as an ordinary loss.
3. The Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions figures the 25% part, and the Schedule D Tax Worksheet applies the rates to each part.
4. Form 8960 figures the net investment income tax.

Choosing the sale year and deferring the tax

The gain is taxed in the year the sale closes. A year with less other income keeps more of the gain in lower brackets and less of it under the 3.8% tax: if the couple in the example had $40,000 of taxable income before the sale instead of $150,000, the same sale would cost about $10,800 less in federal tax. If you are still holding the property, tax planning strategies for rental property income covers other moves that change this bill before you sell.

Two ways to spread or postpone the tax:

• Installment sale: if the buyer pays over time, you report gain as payments arrive, with the 25% depreciation part counted first. Ordinary-income recapture on appliances and other personal property is taxed in the year of sale, even if no payment arrives that year. See installment sales.
• 1031 exchange: trading into like-kind real property that you will also hold for investment or business use postpones the gain on the real estate, including the depreciation part. Use a qualified intermediary to hold the sale proceeds, because receiving the money yourself, or having the right to it, turns the exchange into a sale. Cash you take out, and any mortgage paid off that you do not replace with new debt or added cash, are taxed that year, up to the amount of your gain, after subtracting exchange expenses such as commissions. The deadlines are in 1031 exchange timelines and rules.

If you once lived in the property

If you owned the property and lived in it as your main home for at least 2 of the 5 years before the sale, and you did not exclude gain on another home in the prior 2 years, the home sale exclusion (Section 121) lets you exclude up to $250,000 of gain. A joint return can exclude up to $500,000 if both spouses meet the 2-year use test and neither excluded gain on another home in those 2 years. For a former rental, four limits apply:

• Depreciation for periods after May 6, 1997, is never excluded; it is taxed as the 25%-capped part of the gain.
• Rental years after 2008 and before you moved in are "nonqualified use," and the matching share of the gain is taxable.
• Renting after you move out does not reduce the exclusion, as long as you still pass the 2-of-5-year test on the sale date, which means selling within 3 years of moving out.
• A property you acquired in a 1031 exchange must be owned for 5 years before the exclusion is available.

Example: you lived in a house from 2019 through 2023, rented it out starting in January 2024, and sell it in October 2026 for a $210,000 gain that includes $18,000 of depreciation. You lived there at least 2 of the 5 years before the sale, and the rental came after you moved out, so a single filer excludes $192,000 and pays tax on the $18,000 at ordinary rates of no more than 25%.