Reducing Capital Gains Taxes on a Rental Property

Receiving regular rental income can help you grow wealth in the long term and diversify your income streams. . However, income earned from a rental property isn’t tax-free money; you do have to pay the IRS taxes on it. Capital gains tax can also apply when you sell a rental property. To avoid these taxes taking too big of a chunk from your earnings, there are strategies you can employ, from leveraging tax exemptions and deductions to strategically timing your sale, that can make a substantial difference in your net earnings.

Do you have questions about planning for real estate investing? Consider speaking with a financial advisor.

How Rental Property Is Taxed

There are two dimensions to the tax picture when talking about rental properties. First, there’s the tax you pay on rental income paid to you. Second, there’s the taxes you might pay if you were to sell a rental property for a profit.

In terms of taxes on rental income, that income is subject to the same treatment as any earned income you might have from working or side-hustling. In other words, rental income is taxed as ordinary income at whatever your regular tax bracket may be for the year. The good news is that you can reduce what you owe in income taxes on rental income by claiming deductions for depreciation and rental expenses, such as maintenance, upkeep and repairs.

Meanwhile, when you sell a rental property, you may owe capital gains tax on the sale. Capital gains tax generally applies when you sell an investment or asset for more than what you paid for it. The short-term capital gains tax rate is whatever your normal income tax rate is, and it applies to investments you hold for less than one year. So, for 2025, the maximum you could pay for short-term capital gains on rental property is 37%.

The table below breaks down the 2025 short-term capital gains tax rates by filing status:

Rate	Single	Married Filing Jointly	Married Filing Separately	Head of Household
10%	$0 – $11,925	$0 – $23,850	$0 – $11,925	$0 – $17,000
12%	$11,925 – $48,475	$23,850 – $96,950	$11,925 – $48,475	$17,000 – $64,850
22%	$48,475 – $103,350	$96,950 – $206,700	$48,475 – $103,350	$64,850 – $103,350
24%	$103,350 – $197,300	$206,700 – $394,600	$103,350 – $197,300	$103,350 – $197,300
32%	$197,300 – $250,525	$394,600 – $501,050	$197,300 – $250,525	$197,300 – $250,500
35%	$250,525 – $626,350	$501,050 – $751,600	$250,525 – $375,800	$250,500 – $626,350
37%	$626,350+	$751,600+	$375,800+	$626,350+

Long-term capital gains tax rates, on the other hand, are set at 0%, 15% and 20%, based on your income. These rates apply to properties held for longer than one year. If you own rental property as an investment year over year, you may be more likely to deal with the long-term capital gains tax rate.

For reference, this table breaks down the 2025 long-term capital gains tax rates by filing status:

Rate	Single	Married Filing Jointly	Married Filing Separately	Head of Household
0%	$0 – $48,350	$0 – $96,700	$0 – $48,350	$0 – $64,750
15%	$48,350 – $533,400	$96,700 – $600,050	$48,350 – $300,000	$64,750 – $566,700
20%	$533,400+	$600,050+	$300,000+	$566,700+

Understanding Adjusted Cost Basis and Depreciation Recapture

When calculating capital gains on a rental property, your adjusted cost basis plays a key role in determining how much of your profit is taxable. The cost basis is generally what you paid for the property, plus certain expenses (like closing costs and major improvements), minus depreciation you’ve claimed over the years.

Depreciation allows property owners to deduct a portion of the building’s value each year to account for wear and tear. While this rental property deduction can lower your taxable rental income annually, it also reduces your property’s cost basis. When you sell the property, the IRS “recaptures” that depreciation by taxing it at a special rate, of up to 25%, separate from your standard capital gains rate.

For example, suppose you purchased a rental property for $400,000, allocating $300,000 to the building and $100,000 to the land. Over 10 years, you claimed $109,000 in total depreciation. You later sell the property for $550,000 and incur $25,000 in selling expenses.

Your adjusted cost basis would be:

Purchase price: $400,000
Minus depreciation: –$109,000
Plus selling costs: +$25,000
Adjusted cost basis: $316,000

Based on these figures, the total gain on the sale is $550,000 – $316,000 = $234,000.

Of that, $109,000 is taxed as depreciation recapture (up to 25%), while the remaining $125,000 is taxed at long-term capital gains rates (0%, 15%, or 20%, depending on your income).

This means your actual tax liability can be higher than you expect if you’ve owned the property for many years and claimed significant depreciation.

To help minimize depreciation recapture and other taxes, it’s often worth consulting a financial advisor or tax professional before selling an investment property.

Reducing Capital Gains on a Rental Property

A notepad with "property tax" written on the first page.

If you’re interested in minimizing capital gains tax on rental property or avoiding it altogether, there are three avenues open to you:

Take Advantage of Tax-Loss Harvesting

Tax-loss harvesting is a strategy that allows you to balance out capital gains with capital losses in order to minimize tax liability. So, if your rental property appreciated significantly in value since you purchased it, but your stock portfolio tanked, you could sell those stocks at a loss to offset your capital gains on the rental property.

Essentially, this could cut your capital gains tax bill to zero if you have enough investment losses to cancel out the profits. This strategy assumes, of course, that some of your other investments didn’t perform as well over the previous year.

If your entire portfolio did well over the past year, then you may need to consider other ways to cut your taxes than loss harvesting. It may not yield enough of a benefit to offset all of your capital gains from selling a rental property.

Use a 1031 Exchange

Section 1031 of the Internal Revenue Code allows you to defer paying capital gains tax on rental properties if you use the proceeds from the sale to purchase another investment, known as a 1031 exchange. You don’t get to avoid paying taxes on capital gains altogether; instead, you’re deferring it until you sell the replacement property.

There are a few rules to know about Section 1031 exchanges. First, this is a like-kind exchange, which means that the rental property you buy must be the same type of property as the one you sold. The good news is that the IRS allows for some flexibility in how like-kind is defined. So, for example, if you own a duplex, and you decide to sell it and use the proceeds to purchase a single-family rental home, that could still meet the criteria for a 1031 exchange.

You also need to be aware of the timing when executing a 1031 exchange. If you want to use this strategy to avoid capital gains tax on a rental property, you must have a potential replacement property lined up within 45 days. The closing on the new property must be completed within 180 days. If you don’t meet those deadlines, you’ll owe capital gains tax on the sale of your original rental property.

Again, a 1031 exchange doesn’t let you off the hook for paying capital gains tax on rental property. But it could buy you time for paying those taxes owed if you’re interested in swapping out your rental property for a new one.

Convert a Rental Property to a Primary Residence

One perk of being a homeowner is that the IRS offers a significant tax break if you sell at a profit. Single filers can exclude up to $250,000 in gains from the sale of a primary home from taxation. That amount doubles to $500,000 for married couples who file a joint return.

If you like your rental property enough to live in it, you could convert it to a primary residence to avoid capital gains tax. There are some rules, however, that the IRS enforces. For one, you have to own the home for at least five years. Additionally, you have to live in it for at least two out of five years before you sell it.

This might be something to consider if you’re no longer interested in owning a rental property for income or you’d like to move from your current home into a rental.

Bottom Line

Capital gains tax on rental properties can quickly add up if you’re able to sell a property you own for a large profit. Keeping an eye on conditions in the housing market and reviewing your overall financial situation can help you determine whether it’s the right time to sell to minimize taxes. For example, if your regular income is down for the year, then selling a rental property at a capital gain may not carry as much weight if you’re in a lower tax bracket. Talking to a financial advisor can help you find the best ways to manage capital gains tax.

Tips on Taxes

Tax planning is a key part of financial planning, which is something for which a professional can provide excellent guidance. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Tax-loss harvesting isn’t limited to rental properties. You can also use stock losses to offset stock gains, for example. One thing to keep in mind, however, is the IRS wash-sale rule. This rule specifies that you can’t sell a losing stock and then replace it with a substantially similar one in the 30 days before or after the sale.