Capital Gains Tax on Investment Property: What You Owe

Long-Term vs. Short-Term Capital Gains

When you sell an investment property, the IRS divides your profit into categories taxed at different rates. The holding period is the primary dividing line. Properties held for more than one year generate long-term capital gains, which are taxed at preferential rates of 0%, 15%, or 20% depending on your taxable income. For 2025, the 0% rate applies to single filers with taxable income up to $48,350, the 15% rate applies up to $533,400, and the 20% rate applies above that threshold. Married filing jointly thresholds are roughly double.

Properties held for one year or less produce short-term capital gains, taxed at your ordinary income rate. This can reach 37% at the highest federal bracket. The difference between a 15% long-term rate and a 37% ordinary rate on a $200,000 gain is $44,000 in additional federal tax. This is why most investors structure their timelines to hold properties beyond the one-year mark before selling.

Calculating Your Gain

Your taxable gain is the difference between the net selling price (after closing costs and selling expenses) and your adjusted basis. Adjusted basis starts with your original purchase price plus acquisition costs (title fees, recording fees, transfer taxes). It then increases by the cost of any capital improvements made during ownership and decreases by any depreciation claimed or allowable.

For example, if you purchased a property for $400,000, spent $50,000 on capital improvements, and claimed $60,000 in depreciation over your holding period, your adjusted basis would be $390,000 ($400,000 + $50,000 - $60,000). If you sell for $550,000 with $30,000 in selling costs, your net sale price is $520,000, and your total gain is $130,000.

That $130,000 gain is then split into two components: the depreciation recapture portion ($60,000, taxed at a flat 25% rate under Section 1250) and the remaining appreciation ($70,000, taxed at your applicable long-term capital gains rate).

The Net Investment Income Tax

High-income investors face an additional 3.8% Net Investment Income Tax (NIIT) under Section 1411. This surtax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). Capital gains from property sales, rental income, and interest income all count as net investment income.

On a $200,000 capital gain, the NIIT adds $7,600 to your tax bill. Combined with the 20% long-term rate and the 25% depreciation recapture rate, the effective federal tax rate on a property sale can reach approximately 28% or more for high earners.

One exception applies: investors who qualify as real estate professionals and materially participate in their rental activities may be able to exclude rental income from the NIIT calculation. The rules here are complex and depend on whether the activity is treated as a trade or business under Section 162.

Strategies to Reduce Capital Gains Tax

Several legal strategies can reduce or defer capital gains tax on investment property. A 1031 exchange defers both capital gains and depreciation recapture by rolling the proceeds into a replacement property. An installment sale under Section 453 spreads the gain recognition over the payment period, keeping you in lower tax brackets each year. Opportunity Zone investments under Section 1400Z allow you to defer and potentially reduce capital gains by investing in designated census tracts.

Timing your sale to a year when your other income is lower can also reduce the effective tax rate. If you are retiring or expect a dip in income, selling during that window may keep your capital gains in the 0% or 15% bracket. Charitable strategies, such as donating appreciated property to a donor-advised fund, eliminate the capital gains tax entirely while providing an income tax deduction for the property's fair market value.

For a broader overview of tax planning for rental property investors, see Tax Planning Strategies for Rental Property Income.