How Much Tax Will You Owe When You Sell Your Rental Property?

The honest numbers — and the strategy that changes them.

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You’ve owned your rental property for decades. It’s appreciated significantly. You’re ready to sell, retire, and enjoy the equity you’ve built.

Then your CPA calls with the tax estimate.

The number is larger than you expected. Much larger. And it’s coming from several directions at once — capital gains taxes, depreciation recapture, the net investment income tax, and potentially your state’s income tax on top of everything else.

For many long-term landlords, the combined tax bill on a rental property sale consumes 25 to 40 cents of every dollar of gain. That’s not a rounding error — it’s the difference between a comfortable retirement and a financially constrained one.

This article walks through the four taxes you’ll likely owe when you sell, runs the real numbers on a concrete example ($800K property, purchased for $300K), and then shows you the one IRS-approved strategy that lets you defer all of it: the 1031 exchange into a Delaware Statutory Trust (DST).

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The Four Taxes That Hit When You Sell Rental Property

Most investors know about capital gains tax. Fewer understand the other three taxes that compound on top of it. Here’s a clear breakdown:

1. Federal Long-Term Capital Gains Tax

If you’ve owned your rental property for more than one year, your profit on the sale is classified as a long-term capital gain. The federal tax rates for 2025:

Taxable Income (Single)	Taxable Income (Married Filing Jointly)	Capital Gains Rate
Up to $47,025	Up to $94,050	0%
$47,025 – $518,900	$94,050 – $583,750	15%
Over $518,900	Over $583,750	20%

Most retiring real estate investors who are selling a significantly appreciated property will fall into the 15% or 20% bracket — especially once the gain itself is added to their other income.

2. Depreciation Recapture Tax

This is the one that blindsides investors most often.

When you own a rental property, the IRS allows you to deduct depreciation on the building (not the land) every year — typically over 27.5 years for residential rental property. These deductions reduced your taxable income during the years you owned the property.

When you sell, the IRS “recaptures” those deductions. The depreciation you claimed is taxed at a flat 25% federal rate — regardless of your income bracket. This is separate from and in addition to capital gains tax.

For long-term owners, depreciation recapture can easily reach $50,000–$200,000 or more, representing a significant portion of the total tax bill.

3. Net Investment Income Tax (NIIT)

The Net Investment Income Tax — established by the Affordable Care Act — adds an additional 3.8% tax on investment income (including rental property gains) for higher-income taxpayers:

• Single filers with modified adjusted gross income (MAGI) above $200,000
• Married filing jointly with MAGI above $250,000

This 3.8% stacks on top of your regular capital gains rate. Combined with the 20% rate, that’s effectively 23.8% federal tax on the capital gain portion before state taxes.

4. State Income Tax

Most states tax capital gains as ordinary income or at a separate capital gains rate. Rates vary widely:

• No state tax: Florida, Texas, Nevada, Washington, Wyoming, South Dakota, Alaska
• Low (under 5%): North Carolina (4.5%), Indiana (3.05%)
• Moderate (5–7%): Michigan, Massachusetts, Missouri
• High (8–13%): California (up to 13.3%), New York (up to 10.9%), Oregon (up to 9.9%)

If you live in California and sell a $700,000 gain, you could owe over $90,000 to the state alone.

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The Real Calculation: $800K Property Purchased for $300K

Let’s run this through a realistic scenario that reflects many long-term rental property owners.

The Property:

• Purchase price: $300,000 (purchased 25 years ago)
• Current sale price: $800,000
• Land value at purchase (estimated 20%): $60,000
• Depreciable building value: $240,000

Depreciation Taken Over 25 Years:

• Annual depreciation: $240,000 ÷ 27.5 years = $8,727/year
• Total depreciation claimed over 25 years: ~$180,000
• Adjusted cost basis: $300,000 – $180,000 = $120,000

Gain on Sale:

• Sale price: $800,000
• Adjusted basis: $120,000
• Total taxable gain: $680,000
  • Depreciation recapture portion: $180,000
  • Long-term capital gain portion: $500,000

Tax Breakdown (assuming 20% capital gains rate, married couple, moderate-tax state at 5%):

Tax Component	Rate	Taxable Amount	Tax Owed
Federal long-term capital gains	20%	$500,000	$100,000
Depreciation recapture (federal)	25%	$180,000	$45,000
Net Investment Income Tax	3.8%	$680,000	$25,840
State income tax (5% example)	5%	$680,000	$34,000
Total Estimated Tax			$204,840

Out of an $800,000 sale, you’d take home approximately $595,000 — and write a check for over $200,000.

That’s more than 25% of the entire sale price paid in taxes. And that’s a moderate tax state — in California or New York, the total could easily exceed $275,000–$300,000.

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Why Depreciation Recapture Catches Investors Off Guard

Many investors assume their cost basis is simply what they paid. They’re surprised to learn the IRS adjusts their basis downward by every dollar of depreciation they’ve ever claimed.

Here’s the critical detail: you owe depreciation recapture tax whether or not you actually claimed the deductions. If you were supposed to take depreciation but didn’t, the IRS calculates recapture based on the depreciation you could have taken.

This is why working with a CPA who specializes in real estate is essential before you list your property. Knowing your adjusted basis and exact depreciation history is the foundation of calculating your true tax exposure.

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What You Actually Keep: The After-Tax Picture

Here’s the gut-check version:

Scenario	Amount
Sale price	$800,000
Less real estate agent commissions (~5%)	–$40,000
Less closing costs (~1%)	–$8,000
Net sale proceeds	$752,000
Less total tax (from our example)	–$204,840
What you actually keep	~$547,000

You sold an $800,000 asset. You walked away with roughly $547,000.

Now ask: if you had purchased that property in 1999 for $300,000, you’d net an after-tax, after-cost gain of about $247,000 in real dollars. Meanwhile, that same $800,000 — kept working — could generate $40,000–$50,000 per year in passive income.

The question isn’t just how much you’ll owe in taxes. It’s whether paying those taxes now is the most strategic use of your equity.

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The Alternative: Defer Everything With a 1031 Exchange Into a DST

Here’s where the math changes dramatically.

Under Section 1031 of the Internal Revenue Code, if you reinvest your sale proceeds into a qualifying “like-kind” replacement property, you can defer your entire tax liability — federal capital gains, depreciation recapture, NIIT, and state taxes — to a future date.

In our example:

Path	Capital Available to Invest	Annual Income at 5% Return
Sell outright, pay taxes	~$547,000	~$27,350/year
1031 exchange, defer taxes	~$752,000	~$37,600/year
Difference	$205,000 more working for you	$10,250/year more income

That’s over $10,000 per year in additional retirement income — simply by deferring taxes rather than paying them now.

The Challenge With Traditional 1031 Exchanges

For retiring investors, traditional 1031 exchanges have a significant drawback: you must identify a replacement property within 45 days and close within 180 days — and you must take on that property’s management responsibilities.

Most people who are selling their rental property are trying to exit active management, not find their next tenant headache. The traditional 1031 path forces you back into landlord life.

How Delaware Statutory Trusts (DSTs) Solve This Problem

A Delaware Statutory Trust is a legal investment structure that holds institutional-quality real estate — apartment communities, medical office buildings, net-lease retail centers, industrial warehouses. As a DST investor, you own a fractional beneficial interest.

What that means practically:

• No tenants, no maintenance, no management — completely passive ownership
• Monthly income distributions typically ranging from 4–6% annually
• Qualifies as like-kind replacement property under IRS Revenue Ruling 2004-86 — meaning it satisfies your 1031 exchange requirement
• Minimum investments starting at $100,000–$250,000 — accessible to most landlords with significant equity
• Diversification — you can spread proceeds across multiple DST properties

The result: you sell your rental property, complete a 1031 exchange into one or more DSTs, defer every dollar of taxes, and begin receiving passive monthly income — with zero landlord responsibilities.

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The Estate Planning Dimension: Taxes You May Never Pay

There’s one more dimension worth understanding.

Under current tax law, when you pass away, your heirs receive a stepped-up cost basis — meaning the property’s basis resets to its fair market value at the time of your death. If the DST has appreciated or simply maintained its value, your heirs could sell it immediately and owe zero capital gains tax on all of that deferred gain.

The taxes you deferred through a 1031 exchange may never be paid — by you or your heirs.

Note: Estate tax laws are subject to change. Consult an estate planning attorney regarding how current law applies to your situation.

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What to Do Before You Sell

The single biggest mistake retiring landlords make is waiting until after they’ve listed their property — or worse, after they’ve accepted an offer — to start planning their 1031 exchange.

The 45-day clock starts the moment you close. Once you’re in the exchange window, you have limited time and limited flexibility. The investors who navigate this successfully started their education 6–12 months before selling.

Recommended timeline:

1. 12 months before selling: Review your depreciation history and calculate your adjusted basis with your CPA
2. 6–12 months before selling: Consult with a DST-specialized advisor to understand available offerings
3. Before listing: Engage a Qualified Intermediary (QI) — you must have one in place before closing
4. Within 45 days of closing: Identify your replacement DST property (or properties)
5. Within 180 days of closing: Complete the exchange into your chosen DST(s)

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Ready to Understand Your Options?

The DST Beginner’s Guide breaks down exactly how the DST 1031 process works, what questions to ask a DST sponsor, and how to evaluate whether this strategy is right for your situation.

Download the Free DST Beginner’s Guide →

It covers:

• How DSTs work and what you actually own
• The 7 questions to ask any DST advisor before you invest
• How to compare DST offerings side by side
• Common pitfalls and how to avoid them
• The complete 1031 timeline explained step by step

No jargon. No sales pitch. Just the information you need to make an informed decision.

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Disclaimer: This article is for educational and informational purposes only and does not constitute tax, legal, or investment advice. Tax laws are complex and subject to change. The calculations and examples in this article are illustrative estimates only and are not intended to represent guaranteed outcomes. Capital gains tax rates, NIIT thresholds, and state tax rates are based on 2025 figures and may change. DST investments are private placements available only to accredited investors and involve significant risks, including illiquidity and potential loss of principal. Always consult a licensed CPA, financial advisor, and estate planning attorney before making any investment or tax-related decisions.