Before You Sell
How to Avoid or Defer Capital Gains Tax When Selling Rental Property
Selling an appreciated rental can trigger four different taxes at once. Here are the legal ways investors defer or reduce that bill, and where a 1031 exchange fits.
The Real Number
What you are actually taxed on when you sell
The headline “capital gains tax” is only part of it. Selling an appreciated investment property can trigger up to four layers at once:
- Federal capital gains tax: long-term rates are generally 0%, 15%, or 20%, depending on your taxable income.
- Depreciation recapture: the depreciation you claimed over the years is generally recaptured at a federal rate up to 25%.
- Net investment income tax (NIIT): an additional 3.8% can apply for higher-income taxpayers.
- State capital gains tax: varies widely, from 0% in some states to well over 10% in others.
This page is educational and is not tax advice. Your actual exposure depends on your basis, income, and state. Confirm the figures with your own CPA.
Your Options
Six ways to reduce or defer the tax
1. A 1031 exchange into replacement property
Reinvest the full proceeds into like-kind real estate and defer the entire bill. The trade-off is a strict timeline and identification rules. See 1031 exchange rules & timelines.
2. A 1031 exchange into a DST
To defer the tax without managing another property, a Delaware Statutory Trust lets you 1031 into fractional, professionally managed real estate. See what a DST is and how it compares.
3. An installment sale
Spreading payments over several years under IRC Section 453 can spread the gain into lower-income years without eliminating it.
4. A Qualified Opportunity Zone fund
Rolling the gain into a QOZ fund can defer it and, if held long enough, reduce tax on the new investment’s growth.
5. A 721 exchange / UPREIT for a later exit
Some investors use a DST that later contributes into a REIT for eventual liquidity. See 721 exchange & UPREIT exits.
6. Hold, refinance, or pass on
Continuing to hold, or passing the property to heirs who may receive a stepped-up basis, avoids triggering the sale at all.
The Most Common Path
Where a 1031 exchange fits
For most investors selling a rental, a 1031 exchange is the workhorse: it defers the full tax as long as the proceeds are reinvested into qualifying real estate within the deadlines. The catch is that not everyone wants to buy and manage another building, which is exactly why DSTs exist. Start with the complete DST & 1031 exchange guide, then check who can invest in a DST.
Do Not Miss This
The clock starts the day you sell
A 1031 exchange has two hard deadlines that begin on your sale’s closing date: 45 days to identify replacement property and 180 days to close on it. Miss either and the exchange fails. If a sale is already on the horizon, understand these before you close. The details are on 1031 exchange rules & timelines.
FAQ
Common questions
Can I avoid capital gains tax entirely when selling a rental?
Outright avoidance is rare. The realistic goal is deferral: a 1031 exchange defers the full tax as long as you reinvest in qualifying real estate. Holding until death, when heirs may receive a stepped-up basis, is the main way the gain is never taxed.
How much is capital gains tax on the sale of a rental property?
It depends on your income, basis, and state. Federal long-term rates are usually 0%, 15%, or 20%, plus up to 25% depreciation recapture, a possible 3.8% NIIT, and any state tax. A CPA can model your exact number.
Do I have to pay tax on depreciation I claimed?
Generally yes. Depreciation is recaptured at sale, at a federal rate up to 25%, unless you defer it through a 1031 exchange.
How long do I have to do a 1031 after selling?
45 days from closing to identify replacement property and 180 days to close. Both clocks start on your sale’s closing date and run at the same time.
Not sure which option fits your sale?
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Continue learning
Start with the complete DST & 1031 Exchange Guide, or explore a related topic:
Educational purposes only. 1031InvestorGuide is not an offer to sell or a solicitation to buy any security, and is not tax, legal, or investment advice. Delaware Statutory Trusts are available only to accredited investors through licensed broker-dealers. Past performance is not indicative of future results. Consult your own advisors.
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