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Selling a rental property: the recapture surprise, and five ways out

Depreciation recapture is the tax landlords discover on the closing statement. Here is what a typical 20-year rental costs to sell, and what each strategy does and does not fix.

By , founder, Retirement Literacy Foundation · Updated
Admitted to practice before the IRS.

Short answerSelling a rental can stack four taxes: depreciation recapture at up to 25%, long-term capital gain at 15% or 20%, the 3.8% net investment income tax, and state tax. In this page's 2026 example, a California couple selling a $1,200,000 rental with $250,000 of depreciation owes about $301,500, or 29% of the $1,050,000 gain (IRS Rev. Proc. 2025-32; FTB 2026 schedules; last reviewed October 10, 2026).

Free Big Sale Tax Worksheet

One page that shows every tax layer on your sale: federal capital gains, depreciation recapture, the 3.8% net investment income tax, and state tax.

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The number

What does selling a rental property cost in tax?

Rental bought for $400,000, depreciated $250,000, sold for $1,200,000, married couple, California, 2026

LayerRate (source below)Amount
Depreciation recapture (unrecaptured 1250, $250K)ordinary rates, capped at 25%about $37,500
Long-term capital gain (about $800K)15% / 20%about $140,200
Net investment income tax3.8% of income over $250,000about $30,400
California (whole gain, recapture included)1% to 12.3%, plus 1% over $1 millionabout $93,400
Totalabout $301,500 (29% of the $1,050,000 gain)

Rounded, illustrative, assumes no other income and no selling costs in the year of sale. Federal: 2026 brackets and $32,200 standard deduction (IRS Rev. Proc. 2025-32); California: 2026 FTB rate schedules (FTB Tax News, October 2026). With other income filling the lower brackets, the recapture line rises toward $62,500 (25%). See Sources and review at the bottom of the page.

The options, in plain language

How can you pay less tax or spread it out?

  1. 1031 exchange. Defers everything including recapture. 45 days to identify, 180 to close, qualified intermediary. You stay a landlord. CA tracks out-of-state exchanges.
  2. Delaware Statutory Trust. A 1031 into a passive fractional interest. No management, same deferral, but 5 to 10 years illiquid and 8% to 12% fees. Read the PPM.
  3. Section 453 installment sale. Sell outright, take the price over time (seller note or structured sale). Spreads the gain, including the 25% depreciation slice, which is reported first as payments arrive (Treas. Reg. 1.453-12). Only equipment-type (Section 1245) recapture is all taxed in year one. You are done.
  4. Charitable remainder trust. Deed the property to the trust first; it sells untaxed, pays you 5%+ for life, deduction now. Irrevocable.
  5. Sell and pay in the right year. Retire first, close in January, harvest losses, split across two years. Often cheapest under $500K of gain.
Who this is written for: people who have owned the asset for years, often decades, and are selling once, usually around retirement. If you are buying and selling frequently, different rules (dealer status, ordinary income) apply and this page is not for you.

Six questions to bring to your CPA

  1. How much depreciation have I taken, including any I should have taken?
  2. What is the recapture number by itself?
  3. Does NIIT apply this year, and would a two-year split avoid it?
  4. If I 1031, what happens to the tax if I die owning the new property?
  5. Was this ever my primary residence (Section 121 overlap)?
  6. What does California do if I exchange into Texas?

The deadlines that decide it

  • 1031: 45-day identification, 180-day close, both from the sale closing date.
  • Installment: terms in the contract before closing.
  • CRT: deed before a binding sale agreement.
  • Estimated tax in the quarter of the sale.

Common questions

Straight answers

Does a 1031 defer depreciation recapture?

Yes, a full exchange defers all of it. An installment sale spreads the 25% slice over the payments, first in line, and taxes any equipment-type (Section 1245) recapture in year one.

I lived in it before renting it out. Does the $500K exclusion apply?

If you lived there 2 of the last 5 years, yes on the gain, but not on depreciation taken after May 6, 1997. You can combine 121 and 1031.

What if I owner-finance the buyer?

That is an installment sale. The gain is taxed as principal arrives; interest is ordinary income.

Can I 1031 into a Delaware statutory trust and later into my own property?

Yes, Delaware statutory trusts are 1031-eligible on the way in and out, subject to the sponsor's timeline.

Audit trail

Sources and review

Reviewed for the Retirement Literacy Foundation, a 501(c)(3) education nonprofit. Prepared by Hans Goldstein, EA, retirement educator. Admitted to practice before the IRS. Informational only. Not tax, legal or investment advice. Every figure below cites its source so your CPA or attorney can check it.

Figures are 2026 federal and 2026 California amounts unless stated. Examples are illustrative, rounded, and assume no other income; your numbers will differ. Last reviewed October 10, 2026.

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