How to Minimize Capital Gains Taxes on Rental Property

If you’ve sold a home before, you likely know the process takes more than just listing the property on the open market. You need to prepare it to sell quickly and at a strong price while also considering the transaction’s direct financial impact on you.

Selling a rental property puts cash in your hands but can also trigger a significant tax bill. Like any appreciating investment, your rental property is subject to capital gains tax when sold. Needless to say, proper accounting and bookkeeping is a must.

Fortunately, you can take steps to minimize capital gains on rental property. Below, we’ll explain how these taxes work and outline strategies to reduce what you owe.

What You Need to Know About Capital Gains Tax on Rental Property

When you sell a rental property at a higher price than you paid, your profit is subject to capital gains taxes. For example, if you buy a rental for $250,000 and later sell it for $300,000, you will be liable to pay capital gains tax on the $50,000 profit.

However, several factors affect how much tax you’ll owe. One key consideration is whether the sale qualifies as a short-term or long-term capital gain.

Short-Term Capital Gains

Short-term capital gains happen when you sell an asset for a profit within one year of acquiring it. The IRS taxes these gains at your ordinary income tax rate, which ranges between 10% and 27% based on your taxable income and filing status.

Below is a table with the 2025 short-term capital gains tax rates.

Long-Term Capital Gains

Long-term capital gains occur when you sell an asset at a profit after holding it for over a year. The tax rates for these gains are 0%, 15%, or 20%, depending on your taxable income and filing status.

Below is a chart that breaks down long-term capital gains rates.

How Depreciation Deductions Affect Capital Gains Tax

As a real estate investor, you can take advantage of several tax deductions to lower your taxable income. One of the most significant is depreciation.

The IRS considers buildings (but not land) to lose value over time due to normal wear and tear. Because of this, investors can deduct rental property depreciation each year for up to 27.5 years.

However, when you sell the property, the IRS requires you to repay some of those tax benefits through depreciation recapture, significantly increasing your tax liability in the year of the sale.

How Depreciation Works

To better understand the impact, let’s start by breaking down the depreciation deduction.

Suppose you buy a rental property for $250,000, with the land valued at $40,000. Since land isn’t depreciable, the property’s depreciable value is $210,000 ($250,000 – $40,000).

To calculate your annual depreciation expense, use this formula:

Property value / 27.5 years = Annual Depreciation Amount

For our example, this would be:

$210,000 / 27.5 years = $7,636

You can apply this depreciation expense to offset your net operating income, lowering your taxable income and reducing your overall tax liability.

How Depreciation Recapture Works

Unfortunately, when you sell the rental property, the IRS will require you to repay some depreciation benefits through recapture. Here’s how that works:

When you bought the property, its cost basis was $210,000. However, each year you claim depreciation, the cost basis decreases. If you sell the property after ten years, your adjusted cost basis would be:

$210,000 (original costs basis) – $76,363 (depreciation) = $133,637 (adjusted costs basis)

Since the rental property is in a highly desirable area, with rising rents and sales prices over the past decade, you’ve found a buyer willing to pay $450,000.

However, instead of using the sale price, the IRS requires you to calculate depreciation recapture based on the adjusted cost basis. This adjusted basis accounts for the depreciation deductions you’ve claimed over the years, directly impacting your taxable gains.

$450,000 (sale price) – $133,637 (adjusted costs basis) = $316,363 (realized gain) 

With a total household income of $175,000 and a married filing jointly status, you fall into the 22% tax bracket. Your long-term capital gains tax rate is 15%, meaning the IRS would ideally tax your rental property’s realized gain at that rate.

However, the IRS requires you to recapture depreciation first, meaning they will tax the depreciation deductions you’ve taken over the past ten years at your ordinary income tax rate of 22%. They will then tax the remaining gain at the 15% long-term capital gains rate. This added tax burden makes depreciation recapture a crucial factor when calculating your final tax liability.

• • Tax on recaptured depreciation: $76,363 (Depreciation amount) x 22% = $16,800 
  • Tax on remaining gain: $316,363 – $76,363 = $240,000 x 15% = $36,000

• Total taxes owed on sale: $52,800

To estimate your potential capital gains taxes when selling a rental property, use our Capital Gains Tax Calculator. This tool will help you understand your tax liability by considering purchase price, selling price, improvement costs, and tax filing status.

Methods to Reduce Capital Gains Tax When Selling Rental Property

As you just saw, capital gains tax on the sale of a rental property can take a significant bite out of your profits. That’s why understanding how to reduce your tax burden is essential.

Here are a few ideas about how to do so:

Convert Rental to Primary Residence

Unlike investment properties, primary residences qualify for a capital gains tax exclusion when sold. In 2025, single filers can exclude up to $250,000 in gains, while married couples filing jointly can exclude up to $500,000.

To qualify, you must live in the property as your primary residence for at least two of the five years before selling. If you meet this requirement, you can exclude a significant portion (or even all) of your capital gains, reducing or eliminating your tax liability.

1031 Exchange

A 1031 Exchange is a widely used strategy for minimizing capital gains on rental property. It allows you to defer capital gains taxes by reinvesting the proceeds from a property sale into another investment of equal or greater value.

This strategy is common when upgrading to a larger property. For example, you could sell a single-family rental and buy a duplex or sell a duplex and purchase a six-unit building. As long as you reinvest the proceeds into a new qualifying property, you can delay paying capital gains taxes on the sale.

However, strict timelines apply:

• You must identify the replacement property within 45 days of selling the original property.
• You must complete the purchase within 180 days of closing on the original sale.

Following these guidelines allows you to continue growing your real estate portfolio while deferring capital gains taxes.

Why to Consider Selling When Income is Low

Another effective way to reduce capital gains tax on rental property is to sell when your income is lower. While no one wants to earn less, rental property owners sometimes face months with vacant units, which can reduce overall income.

Since depreciation recapture is tied to your tax bracket, selling in a lower-income year can reduce your tax liability. For example, if your rental income is typically $215,000, you’d fall into the 24% tax bracket. But if vacancies lowered your income to $195,000, you’d move into the 22% bracket, reducing the taxes owed on recaptured depreciation.

This strategy isn’t always practical, so exploring other ways to lower your taxable income before selling is essential.

Tax Loss Harvesting and its Role in Minimizing Taxes

If your rental properties had a strong year and your income remained steady, another way to reduce your tax liability is through tax loss harvesting.

This strategy involves selling an underperforming investment to use the capital loss to offset gains from a profitable investment. While commonly associated with stock portfolios, tax loss harvesting can also apply to real estate.

For example, if you sell a four-unit building and owe capital gains tax on a $60,000 profit, that’s a significant amount. But, if a stock you own has dropped $5,000 in value, you could sell it to realize the loss. Doing so would reduce your taxable capital gain from $60,000 to $55,000 and lower your overall tax burden.

Strategically reducing taxable income can make a big difference when selling rental property, and exploring options like tax loss harvesting can help minimize your capital gains tax burden.

Impact of Rental Income on Capital Gains Tax

One common misconception is that rental income directly affects the capital gains taxes owed when selling a rental property. In reality, rental income is taxed as ordinary income based on your individual tax rate, while capital gains are taxed separately under capital gains tax rates.

If your rental income is high enough, however, it could push you into a higher capital gains tax bracket, increasing the taxes owed when you sell. To help prevent this, reducing taxable income as much as possible is key. Claiming all eligible deductions can make a significant difference.

Here are some deductions that can help lower taxable income:

• Mortgage interest
• Insurance premiums
• Property taxes
• Maintenance fees
• Property management costs
• Utilities
• Rental advertising
• Depreciation

Before selling a rental property, one way to reduce capital gains tax liability is by increasing the cost basis that depreciation has lowered over time. You can achieve this by performing capital improvements, or upgrades that add long-term value to the property.

Examples of capital improvements include:

• Installing a new HVAC system
• Adding an extension to the home
• Replacing the roof or windows

Each of these increases the property’s cost basis, reducing the taxable gain when you sell and ultimately lowering your capital gains tax.

Additional Information to Consider for Special Cases

Whether real estate is classified as an investment property or a vacation home directly impacts how the IRS will tax it when sold.

For example, vacation homes don’t qualify for depreciation deductions, meaning you won’t have to deal with depreciation recapture. However, if you rent out the vacation home for part of the year, depreciation recapture will apply to the rental periods, increasing your potential tax liability.

Like investment properties, vacation homes don’t qualify for the capital gains exclusion that applies to primary residences. To avoid capital gains taxes on a vacation home, you must live in it as your primary residence for at least two of the five years before selling. Doing so can help reduce or eliminate capital gains taxes when you sell the property down the road.

The Final Word

For better or worse, when you sell an investment property, capital gains taxes will apply. Fortunately, several strategies can help reduce your tax liability.

Using TurboTenant with powerful accounting and bookkeeping software by REI Hub can simplify the process. On top of these tracking and reporting tools, TurboTenant also provides access to additional features that can help manage your investment efficiently, including:

• Property advertising
• Rental applications
• Tenant screening
• Lease agreements
• Rent collection

Sign up for a free TurboTenant account today to immediately streamline your property management operation.

Capital Gains Tax on Rental Property FAQ