How to sell a rental property without incurring taxes

Selling a rental property is one of those money moments that looks simple from the outside and gets complicated the second you touch the paperwork. You see a big sale price, you pay off the mortgage, you pocket what is left, and then you remember the taxman wants a slice of the gain. The good news is there are well known paths to lower that slice. The catch is that the rules are specific. If you line up your timing, your basis records, and your next steps, you keep more. If you wing it, you might donate thousands to the Treasury for no reason.

Start with the core idea. When you sell an asset for more than your adjusted basis, you have a capital gain. If you owned the property for a year or less, that gain is short term and taxed at your ordinary income rate. Hold more than a year and it becomes a long-term gain with reduced rates. In 2025, long-term capital gains still sit in three main tiers that coordinate with your filing status. There is a 0% band for lower incomes, a 15% middle, and a 20% top rate, with precise dollar cutoffs published each year. For 2025, the 0% long-term bracket tops out at $48,350 for single filers, $96,700 for married filing jointly, and $64,750 for heads of household. Above those levels you move into the 15% band, and very high incomes hit 20%. These thresholds apply to long-term gains you realize in 2025 and file in 2026.

Ordinary income tax brackets still matter because short-term gains ride those rates. The IRS and independent tax researchers publish the specific cutoffs each year. For tax year 2025, the 10% bracket tops out at $11,925 for singles and $23,850 for joint filers, with the next tiers stepping up through 12%, 22%, 24%, 32%, 35%, and finally 37%. These are inflation-adjusted and determine your short-term capital gains rate if you sell before the one-year mark.

There is also a surtax that catches many higher earners by surprise. If your modified adjusted gross income crosses $200,000 as a single filer or $250,000 as a joint filer, the 3.8% Net Investment Income Tax can stack on top of your capital gains taxes. This applies to rental income and real estate gains among other investment income items, so it is worth modeling if you expect a large sale.

So far, that sounds straightforward. Then depreciation shows up. Rental property owners take depreciation over time and those deductions lower your basis. When you sell at a gain after holding more than a year, the IRS wants to claw back the part of the gain that is simply reversing past depreciation. That portion is called unrecaptured Section 1250 gain and it is taxed at a maximum 25% rate, separate from the 0% or 15% or 20% long-term buckets. If you depreciated your building for years, expect this line to matter. The IRS explains it plainly in Topic 409 and Publication 544, and there is even a worksheet in the Schedule D instructions to compute the exact amount.

The next big lever is the primary residence exclusion under Section 121. If you own and use a home as your main residence for at least two years within the five years before the sale, you can exclude up to $250,000 of gain if you file single or up to $500,000 if you file jointly. The years do not have to be consecutive. If you convert a rental to your home and then meet the use and ownership tests, you can apply the exclusion to the qualifying part of the gain. That is real money when you are moving into a former rental. The IRS summarizes the rule in Topic 701 and expands it in Publication 523.

There are two reality checks with that strategy. First, depreciation does not disappear just because you move in. Any unrecaptured Section 1250 gain tied to depreciation remains subject to the 25% cap even when you otherwise qualify for the home-sale exclusion. Second, there are “nonqualified use” rules for periods after 2008 when the property was not your primary residence. Those periods can reduce the portion of gain eligible for exclusion, which is another reason to run the numbers before you commit to moving. Publication 523 covers how to allocate the gain and which months count for or against you when a property switches use.

If you plan to keep investing rather than cashing out, the classic deferral path is a 1031 exchange. Sell an investment property, park the proceeds with a qualified intermediary, identify your replacement property within 45 days, and close within 180 days. Do it correctly and you defer recognition of the gain and the tax bill rolls into the new asset. The IRS lays out those exact timing requirements in the 8824 instructions and in exchange guidance. The window is tight, so serious buyers often line up candidates before they even close the first sale.

Let us translate timing into real life. Say you sold your duplex on March 1. Your 45-day identification clock runs into mid-April. Your 180-day completion deadline lands in late August unless your tax filing date cuts it shorter. A qualified intermediary must hold the proceeds during the exchange, and the replacement property must be like kind, which is broad for real estate. Equal or greater value is a practical constraint if you want to defer all tax, and any boot you receive can trigger partial taxation. Those details sound fussy because they are what breaks most failed exchanges. The rules are meant to force a true property-for-property swap, not a sale dressed up as one.

What if you are exiting real estate altogether or you want to simplify without a 1031? You still have ways to dial the pain down. The easiest one is time. If you are still inside a one-year holding period, crossing day 366 turns a short-term gain into a long-term one, which usually drops the federal rate a lot. That single calendar pivot can save five figures on a mid-six-figure gain. The second is income planning. If your salary is variable, or you are headed into a gap year or early retirement, sell in the low-income year. Long-term capital gains brackets are keyed to taxable income, so a lower AGI can put part of your gain inside the 0% or keep you away from the NIIT surtax. The thresholds above are where you test that.

Then there is tax-loss harvesting. This is the practice of selling investments in your brokerage account at a loss so those losses offset your realized gains. It does not apply to the property itself, but it does apply to your stocks, ETFs, and mutual funds. Losses first net against gains, and if you still have more losses than gains, you can deduct up to $3,000 of the leftover against ordinary income, with any excess carried forward to future years. The IRS describes the $3,000 limit in Topic 409 and codifies it in Section 1211. A few reminders help keep it clean. Harvest in a taxable account, not an IRA. Watch the wash-sale rule, which disallows a loss if you buy the same or substantially identical security within 30 days before or after you sell it. Buy a similar but not nearly identical fund if you want to stay invested while the clock runs. Brokerage education pages spell this out with clear examples.

Record keeping is not the fun part of real estate investing, but it is where thousands of dollars hide. Your capital gain is sale proceeds minus your adjusted basis, and basis is not just what you originally paid. Basis starts with the purchase price. It goes up with capital improvements and certain acquisition costs. It goes down with depreciation taken or allowable. Then, at sale, you reduce your gain by costs to sell, such as legal fees, commissions, and advertising. Publication 544 is the source of truth on how to adjust basis and compute gains, and Publication 523 shows how to calculate the home-sale exclusion if you qualify. If there is one habit I would force on every landlord, it is to keep a running basis worksheet with receipts. Future you will thank present you.

Let us put some numbers to it. Imagine you bought a rental for $300,000, allocated $240,000 to the building and $60,000 to land, and you took $50,000 of depreciation over several years. You sell for $400,000 with $24,000 in combined closing costs and commissions. Your preliminary gain is sale price minus selling costs minus adjusted basis. Adjusted basis is purchase price plus improvements minus depreciation. If you put $20,000 into a new roof along the way, your adjusted basis would be $300,000 plus $20,000 minus $50,000, which is $270,000. Subtract that from $376,000 in net proceeds and you get a $106,000 gain. Of that, up to $50,000 is unrecaptured Section 1250 gain that can be taxed at up to 25%. The remainder falls into the long-term gain bucket if you held more than a year, then rides the 0%, 15%, or 20% schedule based on your income. If your MAGI is high enough, add the 3.8% NIIT on top. The IRS topics and publications we cited above map to each line of that math.

There is a different angle if your rental was part of your home or was your home and later became a rental. People convert basement apartments, rent out a portion of a duplex, or move out and rent the whole house. When you sell, the rules do not punish you, but they do separate use. Office or rental portions inside your primary residence can still benefit from the home-sale exclusion but depreciation you took for those portions is still subject to the 25% unrecaptured rate. If the rental space is in a separate structure, that piece may be treated differently for exclusion. Publication 523 works through these edge cases, and it is worth an hour to read the examples because the treatment depends on details like how you claimed or did not claim depreciation.

Another knob to turn is installment sales. If a buyer pays you over time and you do not elect out of installment treatment, you can receive principal and gain over several years, smoothing out your taxable income. Unrecaptured Section 1250 gain does not vanish in an installment sale. The regulations allocate it across payments and you recognize that 25%-capped portion first when gain is reported, which is one reason to run scenarios with a professional before you agree to be the bank for your buyer.

Now let us talk about traps. The first is assuming states match federal rules. Many do not. Some states do not conform to the home-sale exclusion exactly, some have different capital gains taxes, and a few have no income tax at all. State rules can change net proceeds by a lot, and they can also govern withholding at closing for nonresidents. The second trap is blowing the 1031 timing by a single day or trying to touch the proceeds. Once the funds are in your hands, your exchange is over. Use a qualified intermediary and calendar the deadlines on day one. The third is thinking a last-minute move-in always saves you. If you do not meet the two-years-inside-five test, you likely will not get the full exclusion. You may qualify for a partial exclusion in specific hardship situations, but that is a narrow path. The IRS publications and Topic pages outline the exceptions, and they are narrower than the internet rumor suggests.

So what is a calm and realistic plan if you are holding a rental with a big gain on paper. First, decide if you are exiting real estate or continuing. If you are continuing and the numbers work, structure a 1031 exchange and line up replacement candidates early. If you are exiting, check your holding period and your income trajectory. If you can wait for long-term treatment or for a lower income year, that is often the cleanest savings. If converting to a home is on the table and you actually want to live there, map the two-out-of-five clock and read Publication 523 with the nonqualified use rules in mind. In parallel, open your brokerage statements and see whether you can harvest capital losses without wrecking your asset allocation or triggering wash sales. If you are close to NIIT thresholds, model whether a retirement contribution or a timing shift keeps your MAGI under the line. Then document every improvement and expense so your basis is right. It sounds boring. It is also where the savings live.

A last word on expectations. Tax law is written in definitions and exceptions. Most of the big wins are simple moves done early. Waiting until you have a signed contract is how people end up with unnecessary surtaxes or a failed exchange. A one-hour chat with a CPA who regularly handles real estate can pay for itself quickly when unrecaptured Section 1250 gain, NIIT, or partial exclusions are in play. The system rewards you for aligning your sale to your timeline. The system is less kind when you ask for forgiveness after the fact.

If you remember only one sentence, make it this. Capital gains tax on rental property is not just about the rate you see on a chart. It is about timing, use, basis, and whether you are moving money into the next asset or out of the game. The more intentional you are with those four, the more of your profit you keep.