When you sell an investment property, the IRS, your state, and the depreciation recapture rules each take a slice. Most landlords are surprised by how big the combined bill is — and by how much of it can legally be deferred.
The three layers of tax on a real-estate sale
A typical sale triggers three separate tax liabilities. Each is calculated on a different base, at a different rate, by a different authority. Getting them right matters because they stack.
- Federal capital gains tax — 15% or 20% on the long-term gain (purchase price subtracted from sale price), depending on your ordinary income bracket
- State income tax — 0% in Florida, Texas, and seven other states; up to ~13% in California, ~10% in New York and New Jersey
- Depreciation recapture — 25% federal tax on every dollar of depreciation you claimed (or could have claimed) over the years you owned the property
A quick example
Buy a duplex in 2008 for $250,000. Sell it in 2026 for $700,000. You've claimed (or should have claimed) about $145,000 of depreciation along the way. You live in California.
- Gain: $450,000
- Federal capital gains (20%): $90,000
- California state tax (~10.75%): $48,375
- Depreciation recapture (25%): $36,250
- Total: $174,625 — about 39% of your gain
That's the number most landlords don't see coming until their CPA delivers the news after closing.
The deferral options
The IRS gives investment-property owners three legal ways to defer this tax — sometimes indefinitely:
- 1031 exchange — sell and reinvest in like-kind real estate within strict deadlines (45 days to identify, 180 days to close)
- Delaware Statutory Trust (DST) — 1031-eligible passive ownership in institutional real estate. No tenants, monthly distributions, accredited investors only
- Opportunity Zone fund — invest the gain in a designated Qualified Opportunity Zone; defer until 2026, with potential basis step-up if held 10+ years
What to do before you list
The single biggest mistake is waiting until after the closing to learn about your options. By then, the qualified intermediary paperwork can't be signed, the 1031 window is closed, and the tax is locked in.
If you're even considering selling within the next 12 months, the right order of operations is:
- Run the numbers on what you'd actually owe (use our free capital gains calculator)
- Decide whether you want to keep working the property, exchange into something else, or fully exit
- Pick a qualified intermediary before you sign a listing agreement — not after
The math almost always favors deferring. The hard part is starting the conversation early enough to have the choice.