Capital Gains (on Rental Sale)

A capital gain on a rental sale is the profit you make when you sell a property for more than your adjusted basis, the price you paid plus improvements minus the depreciation you took. If you owned the property for more than a year, the gain is taxed at long-term capital gains rates, which run lower than the ordinary income rates that apply to a property held a year or less.

In practice

Say you buy a duplex for $300,000, put $30,000 into a new roof and kitchens over the years, and take $40,000 of depreciation while you own it. Your adjusted basis is $300,000 plus $30,000 minus $40,000, which lands at $290,000. You sell for $420,000 and pay $25,000 in closing costs, so your amount realized is $395,000. The total gain is $395,000 minus $290,000, or $105,000.

That $105,000 does not all get the friendly rate. The $40,000 of depreciation you wrote off comes back first as depreciation recapture, taxed up to 25 percent. The remaining $65,000 is your true long-term capital gain, taxed at 0, 15, or 20 percent depending on your taxable income for the year. Holding period matters: had you sold inside twelve months, the whole gain would be short-term and taxed as ordinary income, which for most landlords is a higher bracket.

Why it matters to a small landlord

The gain you owe is decided years before you sell, by the basis math you keep along the way. Every improvement you forget to add raises the gain; every year of depreciation you took lowers your basis and feeds the recapture bucket. That is why the moment to get this right is while you own the property, not the week you list it. It helps to know how depreciation works on a rental and to walk the full sale through the taxes on selling a rental before you sign a listing agreement, because the timing of the closing can move you into a different rate.

Capital gains never travel alone. They ride with depreciation recapture, the part of the gain that traces back to write-offs you already used; they are measured against your cost basis, the running number that decides the whole bill; and they can be deferred entirely with a 1031 exchange if you roll the proceeds into another property. Get the basis right while you own it, and the sale year holds no surprises.