If you're thinking about selling a rental property, the number that matters isn't your sale price — it's what you keep after tax. For long-held properties with significant appreciation, the tax bill can be larger than most owners expect, because it's not just capital gains tax. Three separate taxes can apply at once, and missing one of them is the most common mistake sellers make.
The three taxes that hit when you sell
1. Depreciation recapture. Every year you owned the property, you (or your accountant) likely deducted depreciation against your rental income — typically 1/27.5th of the building's value annually. When you sell, the IRS "recaptures" that benefit. This portion of your gain, called unrecaptured Section 1250 gain, is taxed at your ordinary income rate, capped at 25% federally. Many sellers forget this exists entirely until they see the tax bill.
2. Long-term capital gains. Whatever profit remains after backing out the recaptured depreciation is taxed at the standard federal capital gains rates — 0%, 15%, or 20%, depending on your total taxable income for the year of sale.
3. Net Investment Income Tax (NIIT). If your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), an additional 3.8% surtax applies to some or all of the gain.
On top of these, most states also tax capital gains — some (like California) tax them as ordinary income with no preferential rate at all, while others (Texas, Florida) have no state income tax whatsoever.
Why recapture catches people off guard
Here's a simplified example. Say you bought a rental for $450,000, held it for 20 years, and it's now worth $500,000. That sounds like a modest $50,000 gain. But if you've taken $265,000 of depreciation over those 20 years, your adjusted basis is much lower than your purchase price — and your actual taxable gain is closer to $280,000, not $50,000. The recapture tax alone, before any capital gains or state tax, can run into six figures on a property like this.
This is the scenario that trips up long-term owners specifically: the longer you've held the property, the larger your accumulated depreciation, and the bigger the gap between "what it sounds like I made" and "what I'm actually taxed on."
Ways to reduce or defer the tax
1031 exchange. Instead of selling outright, you can exchange into another investment property and defer the entire tax bill — recapture, capital gains, NIIT, and state tax — as long as you follow strict IRS timing rules (45 days to identify a replacement, 180 days to close) and reinvest all your equity into a property of equal or greater value. The tax isn't eliminated, just deferred until you eventually sell without exchanging again.
Hold until death. If you never sell and instead pass the property to heirs, they receive it at a "stepped-up" basis equal to its value at your death. All the deferred tax — including gain from a prior 1031 exchange — disappears. This is sometimes called "swap till you drop" when combined with 1031 exchanges along the way.
Cash-out refinance. Refinancing isn't a sale, so pulling equity out via a new loan isn't taxable at all. It lets you access cash without triggering any of the three taxes above — though it does increase your debt service going forward.
Which option actually leaves you with more money?
This is where it gets genuinely hard to eyeball. Whether holding, selling, refinancing, or exchanging leaves you better off depends on your specific numbers: how much you've depreciated, your current loan terms, your state, your income bracket, and what you'd otherwise do with the cash. A property with thin cash flow might make holding look attractive on paper but actually cost you money every year you keep it. A big embedded gain might make a 1031 exchange look appealing, but only if the replacement property is properly funded.
There's no universal right answer — it depends entirely on your specific situation, run through the actual tax mechanics rather than a rule of thumb.
Two deeper dives on the pieces most people miss: how depreciation recapture actually works (often the biggest single line on the tax bill for long-held rentals), and 1031 exchange vs. selling — when deferring the tax actually leaves you with more money and when it doesn't.
This article is for general information only and isn't tax, legal, or investment advice. Tax rates and rules change — confirm current figures with a CPA before making a decision. Rates referenced above reflect 2026 federal brackets.