No gain, no capital gains tax
Capital gains tax applies only to gains. If your adjusted basis (purchase price plus improvements, minus depreciation) exceeds your net selling price, you have a loss rather than a gain, and no capital gains or depreciation recapture tax applies. The loss may actually be valuable.
Rental property sales are Section 1231 transactions. If your net Section 1231 gains and losses for the year are negative (a net loss), the net loss is treated as an ordinary loss — deductible against any income, not just capital gains. This is one of the favorable features of real estate: losses are ordinary, but long-term gains receive capital gains rates.
Suspended passive losses are released
If you have accumulated passive activity losses from the rental that you couldn't use in prior years (because of the passive activity loss rules), the year you sell the property in a fully taxable transaction releases all suspended passive losses. You can deduct them in full in the year of sale, even if you have no other passive income — they convert to ordinary deductions.
This means selling at a small loss, or even a gain, can still be tax-favorable if it unlocks years of suspended passive losses that offset your other income.
Depreciation recapture when selling at a loss
If you sell below your original purchase price but still above your adjusted basis (which is reduced by all depreciation you claimed), there is still a taxable gain — and depreciation recapture applies to it. For example: purchased at $400,000, claimed $60,000 depreciation, basis is $340,000, sold at $360,000. The $20,000 gain is less than the $60,000 depreciation, so the entire $20,000 is recaptured as unrecaptured Section 1250 gain at up to 25%.
Frequently asked questions
Do I owe tax if I sell a rental at a loss?
No capital gains tax is owed if you have a true loss. If the sale price is below your adjusted basis, the net Section 1231 loss may be deductible as ordinary income.
What happens to passive losses when I sell a rental at a loss?
All suspended passive losses are released in the year of a complete, taxable disposition. They become ordinary deductions available against any income in that year.
Can I still owe depreciation recapture if I sell below purchase price?
Yes — if the sale price exceeds your adjusted basis (which was reduced by depreciation), there is gain equal to that difference, all of which is recapture.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.