How to Reduce Capital Gains Tax on Rental Property

What you are taxed on

The gain on a rental is the sale price less selling costs and your adjusted basis: what you paid, plus buying costs and improvements, minus the depreciation allowed or allowable. For a property held more than a year, the federal tax has three parts. The part of the gain from depreciation, unrecaptured section 1250 gain, is taxed at your ordinary rate but no more than 25%. The rest is taxed at 0%, 15% or 20%, depending on your taxable income. And the 3.8% net investment income tax can apply when modified adjusted gross income is above $200,000 ($250,000 joint). Most states tax the gain too.

Take a rental bought in 2016 for $300,000 and sold ten years later for $520,000 by a single filer in California with $160,000 of other income. The gain is $271,818.18, of which $89,018.18 is from depreciation, and the total tax is $83,731.97. Each strategy below works on one of those parts.

How much each strategy saves

Basis and timing are always available; a move or a lower-income year depends on your plans. The rental property capital gains tax calculator runs these comparisons for your sale, with your state.

Raise your basis with records

Every dollar of basis is a dollar less gain. Buying costs such as title fees and transfer taxes, improvements (a new roof, an addition, replacing a system) and selling costs all count, but only with records. Repairs that keep the property in working order are deducted as expenses in the year you pay them and don't add to basis; improvements that better, restore or adapt the property are added to basis and depreciated. Going through old invoices before you sell can be the cheapest saving there is.

Time the sale

• Hold for more than a year. A gain on property held a year or less is short-term and taxed at ordinary rates, with no access to the 0%, 15% and 20% rates.
• Sell in a lower-income year. For 2026, taxable income up to $49,450 for a single filer ($98,900 joint) is taxed at 0% on long-term capital gain, and up to $545,500 ($613,700 joint) at 15%. A year after retiring or between jobs can put more of the gain in the lower brackets and below the net investment income tax threshold.
• Spread it out. An installment sale is a sale where you receive at least one payment after the year of sale, and you can generally report part of the gain as each payment arrives. Carrying a note for the buyer keeps each year's gain smaller; the seller financing calculator works out the payments.

Defer it with a 1031 exchange

A like-kind exchange under section 1031 defers the whole gain, depreciation included, if you reinvest in real property held for business or investment and follow the rules: a qualified intermediary holds the money, replacement property is identified within 45 days and acquired within 180 days, or by the due date of your tax return if that comes first. In the example, a full exchange would defer $83,731.97 of tax. The gain carries into the new property's basis, so it is postponed, not forgiven. The 1031 exchange calculator shows the deferred gain and any taxable boot, and the guide to 1031 exchange rules covers the deadlines.

Exclude it if you lived there

If the rental was your main home for at least 2 of the 5 years before the sale, the section 121 home sale exclusion can cover up to $250,000 of gain ($500,000 for most married couples filing jointly). Two parts stay taxable: the depreciation after May 6, 1997, and a share of the gain for periods after 2008 when it wasn't your main home. Moving back into a rental before selling therefore helps less than it once did. The Section 121 exclusion calculator works out the exclusion day by day.

Offset it with losses

Capital losses from other sales offset capital gains. Passive losses from the rental that you couldn't deduct in earlier years are generally allowed in full in the year you sell your entire interest to an unrelated buyer in a fully taxable sale, which offsets part of the gain's effect on your income. Check your prior returns for carryforwards before you estimate the tax.

What doesn't work

Skipping depreciation doesn't avoid the tax on it: the basis is reduced by the depreciation allowable whether or not you claimed it, as the guide to depreciation recapture if never claimed explains. And a sale to a relative or a partial sale doesn't release suspended passive losses.

State tax and the net investment income tax

State tax can be as large as any federal saving. In the example, California adds $25,827.08, because it taxes the gain at its regular income tax rates; a state without an income tax would add nothing, and several states exclude part of the gain or tax it at a special rate. The table of state tax on selling a rental compares one sale in every state, and each state's page in the calculator explains its rule.

The net investment income tax adds 3.8% on the smaller of your net investment income or the amount by which modified adjusted gross income exceeds the threshold. In the example it is $8,809.09: the gain pushes income well above $200,000. Spreading the gain over several years or selling in a lower-income year can keep more of it below the threshold.