Capital gains tax on real estate

Every strategy in this pillar, the 1031 exchange, the installment sale, the opportunity zone, the step-up at death, exists to defer or avoid one thing: the capital gains tax on your real estate. So it is worth understanding exactly what that tax is, because “what a 1031 saves you” is only meaningful once you know what you would otherwise owe. The tax comes in layers, and on a depreciated rental the layers stack in ways that surprise sellers.

Long-term versus short-term

The first fork is how long you held the property. Hold it more than one year and your gain is long-term, taxed at the preferential rates that make real estate attractive. Hold it one year or less and the gain is short-term, taxed as ordinary income at your regular bracket, up to 37%. For real estate investors, almost everything is long-term; short-term gain is mostly a flipper’s problem, and flips have their own dealer-property issues.

Long-term rates for 2026 are 0%, 15%, or 20%, depending on your taxable income. The 0% bracket runs up to about $49,450 of taxable income for a single filer and $98,900 for a married couple filing jointly; 15% applies up to roughly $545,500 single and $613,700 joint; 20% applies above that. Critically, long-term gains stack on top of your ordinary income: your wages fill the brackets first, and the gain is taxed at the rate matching where it lands on top.

Real estate held over a year gets long-term rates of 0, 15, or 20% by income; held a year or less, the gain is taxed as ordinary income up to 37%.

The two layers that hit real estate specifically

Two more layers apply to real estate that a stock investor may never see.

The 3.8% net investment income tax, the NIIT, is a surtax on investment income, including rental income and gains, for taxpayers with modified AGI above $200,000 single or $250,000 joint. It stacks on top of the capital gains rate, so a high earner in the 20% bracket actually pays 23.8% on the gain. A materially participating real estate professional can escape the NIIT on rental income and gain, one more reason that status matters.

And the depreciation layer, the one sellers forget. The portion of your gain attributable to depreciation you took, unrecaptured Section 1250 gain, is taxed at a maximum of 25%, higher than the 15% or 20% long-term rate, and the cost-segregated Section 1245 components recapture at ordinary rates up to 37%. So on a long-held, depreciated rental, a big slice of your “capital gain” is actually recapture taxed above the headline capital gains rate. This is why the tax on selling a rental is almost always larger than owners expect, and why deferring it is worth so much.

Real estate gain carries two extra layers: a 3.8% surtax for high earners, and depreciation recapture taxed up to 25% or, for cost-seg components, ordinary rates, above the headline capital gains rate.

Why this makes the deferral tools valuable

Add the layers on a depreciated property in a high-tax state and the total can approach or exceed a third of the gain: 20% federal capital gains, plus 3.8% NIIT, plus 25% on the depreciation piece, plus state tax that can run to 13.3% in California. That combined bite is exactly what a 1031 defers, what an installment sale spreads, what an opportunity zone can partly erase, and what a step-up at death eliminates entirely. Knowing the real number, including recapture and NIIT and state, is the only way to judge whether a deferral strategy is worth its cost and constraints.

The bottom line

• Property held over a year gets long-term rates of 0, 15, or 20% by income; a year or less is ordinary income.
• Long-term gains stack on top of ordinary income and are taxed at the rate where they land.
• A 3.8% NIIT surtax hits high earners, raising the top effective rate to 23.8%.
• Depreciation recapture is taxed up to 25%, and cost-seg components at ordinary rates, above the headline rate.
• The all-in tax on a depreciated rental is far higher than the headline rate, which is what the deferral tools save.

For how a 1031 defers all of this, read beginner’s guide to 1031 exchanges. For the ultimate escape, see step-up in basis. For the full picture, start at the 1031 exchanges and exit planning hub.

Last verified August 2026.