Real Estate Tax Calc
The four main tax streams from investment property
Investment real estate generates income and expenses across the entire holding period, and then a taxable event at the end. First, rental income: each month's rent is ordinary income, offset by deductible expenses including mortgage interest, property taxes, insurance, repairs, and depreciation. Second, depreciation: a non-cash annual deduction that reduces taxable rental income but also reduces your adjusted basis and creates future recapture liability. Third, capital gains: when you sell, the difference between the sale price and your adjusted basis is taxed as Section 1231 gain (long-term capital rates for properties held more than one year). Fourth, depreciation recapture: the portion of gain attributable to accumulated depreciation is taxed at a maximum rate of 25% under the unrecaptured Section 1250 gain rules, regardless of your ordinary income tax bracket.
These streams interact. Depreciation reduces current-year rental income tax but increases future recapture tax. Rental losses absorbed in prior years reduce future basis. The net investment income tax (a 5th stream for high-income investors) can apply to all of the above. Planning across all four simultaneously — rather than optimizing each in isolation — produces the best after-tax outcome.
How rental income is taxed
Rental income is taxed as ordinary income at your marginal federal rate (10% to 37%). It is reported on Schedule E and flows to your Form 1040. Deductible rental expenses include mortgage interest, property taxes, insurance premiums, repairs and maintenance (not capital improvements), utilities paid by the landlord, property management fees, advertising, legal and accounting fees, travel to the property for management purposes, and depreciation.
Net rental income — or loss — is passive income for most landlords. If rental expenses exceed rental income (a rental loss), the passive activity rules of IRC Section 469 limit how much of that loss you can deduct against your wages or business income. The annual $25,000 rental loss allowance lets taxpayers with adjusted gross income under $100,000 deduct up to $25,000 of rental losses against non-passive income each year, phasing out between $100,000 and $150,000 of AGI. Rental professionals who qualify under IRC Section 469(c)(7) can deduct rental losses without limit, but qualification requires more than 750 hours of real estate services per year and real estate as the primary professional activity.
How MACRS depreciation works for rental property
Depreciation is the cornerstone rental property deduction: a non-cash write-off that reduces your taxable rental income each year over the property's recovery period. Residential rental property uses a 27.5-year straight-line schedule under MACRS. Commercial rental property uses a 39-year straight-line schedule.
To calculate the annual depreciation deduction: determine the depreciable basis (purchase price plus acquisition costs, minus land value, plus major capitalized improvements), then divide by 27.5 or 39. A residential rental with a $300,000 depreciable basis generates roughly $10,909 in annual depreciation. Every dollar of depreciation taken reduces your basis by one dollar, increasing the eventual gain on sale. Depreciation provides a current-year tax benefit but creates a future recapture cost — it is a deferral, not an elimination, of tax.
Capital gains tax on the sale of investment property
When you sell an investment property held more than one year, the gain is classified as Section 1231 gain (long-term capital) and is taxed at preferential long-term capital gains rates: 0% (for taxpayers in the 10–12% ordinary income bracket), 15% (most taxpayers), or 20% (for those above certain income thresholds, approximately $518,900 for single filers in 2025).
The gain is computed as: sale price minus selling costs minus adjusted basis. Adjusted basis equals the original purchase price plus acquisition costs plus capital improvements minus total depreciation taken (allowed or allowable) over the holding period. The larger your accumulated depreciation, the lower your adjusted basis and the larger your total taxable gain. Section 1231 also has a net-loss benefit: if total Section 1231 losses for the year exceed Section 1231 gains, the net loss is treated as an ordinary loss — fully deductible against any income, with no annual cap.
Depreciation recapture: the 25% rate
The most misunderstood rental property tax is depreciation recapture. When you sell, all the depreciation you took (or should have taken) over the holding period is subject to recapture at a maximum federal rate of 25% — the unrecaptured Section 1250 gain rate. This rate applies regardless of your ordinary income tax bracket.
Example: if you bought a property for $350,000, depreciated it by $100,000 over 10 years (adjusted basis now $250,000), and sell for $450,000, your total gain is $200,000. The first $100,000 is recapture taxed at up to 25%; the remaining $100,000 is Section 1231 gain taxed at the standard long-term capital gains rate (likely 15%). Investors who hold property for decades with consistent depreciation deductions often find that accumulated recapture is the largest component of their eventual tax bill.
The net investment income tax on rentals
High-income investors owe an additional 3.8% net investment income tax (NIIT) under IRC Section 1411 on net rental income and rental property sale gains. The NIIT applies when your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). These thresholds are not indexed for inflation.
For rental income: the net rental income from Schedule E is included in net investment income and subject to the 3.8% surcharge. For a sale: the Section 1231 capital gain and unrecaptured Section 1250 recapture gain are both included in net investment income. On a $200,000 total gain, the NIIT adds up to $7,600. The NIIT does not apply to income from a trade or business where the taxpayer materially participates, but rental real estate gain on sale is generally still subject to NIIT for most investors.
Property taxes as a deduction and SALT limits
Property taxes on investment properties — unlike primary residences — are fully deductible as business expenses on Schedule E without being subject to the $10,000 SALT cap. The $10,000 cap on state and local tax deductions under the Tax Cuts and Jobs Act of 2017 applies to taxes deducted on Schedule A (personal use). Property taxes on rental and investment properties are deducted on Schedule E, and they are not subject to the SALT limitation.
This is an important distinction. A homeowner with a $15,000 primary residence property tax bill deducts only $10,000 of it (subject to SALT cap). The same investor with a $15,000 property tax bill on a rental property deducts the full $15,000 on Schedule E. Investor-owners who own multiple rentals in high-tax states therefore benefit significantly from the full deductibility of rental property taxes.
Tax strategies over the holding period
Effective investment property tax management is proactive and spans the entire holding period. Key strategies: Cost segregation — a formal engineering study that reclassifies building components into shorter-lived asset classes (5, 7, or 15 years) to accelerate depreciation; most beneficial in the first few years of ownership. Real estate professional status — if you or your spouse spends more than 750 hours per year in real estate activities and more than 50% of professional time, rental losses become fully deductible. 1031 exchanges — deferring capital gains and recapture indefinitely by rolling proceeds into like-kind replacement property.
Qualified Opportunity Zone investments — investing capital gains in a QOZ fund defers and potentially reduces the gain while eliminating tax on appreciation in the QOZ investment held 10 years. Installment sales — spreading gain recognition across multiple tax years to manage bracket exposure. Each strategy involves trade-offs, and the best combination depends on your specific income profile, holding period, property type, and long-term disposition plans.
Worked example: lifetime tax on a rental sold after 15 years
Consider an investor who buys a residential rental for $300,000 (with $240,000 allocated to the building) and sells it 15 years later for $450,000 after $25,000 of selling costs. Over 15 years they claim roughly $130,909 of straight-line depreciation ($240,000 ÷ 27.5 × 15), reducing adjusted basis to about $169,091.
At sale, the amount realized is $425,000 ($450,000 − $25,000). Total gain is roughly $255,909 ($425,000 − $169,091). That gain splits into two buckets: unrecaptured Section 1250 gain of about $130,909 (the depreciation taken), taxed at up to 25%, and Section 1231 capital gain of about $125,000 (appreciation above cost), taxed at 0%, 15%, or 20%. A 15%-bracket investor would owe roughly $32,700 on the recapture (at 25%) plus $18,750 on the capital gain (at 15%) — about $51,450 federal — before any 3.8% net investment income tax or state tax. This illustrates why recapture is often the largest single component of a long-held rental's eventual tax bill, and why 1031 exchanges and the step-up at death are such powerful deferral tools.
State income tax on investment property
Federal tax is only part of the picture. Most states tax rental income and property sale gains as ordinary income at the state marginal rate, and several states do not grant the preferential long-term capital gains rate that federal law provides — meaning the gain on sale can be taxed at the full state ordinary rate. A handful of states — Florida, Texas, Nevada, Washington, South Dakota, Wyoming, and Tennessee — impose no broad personal income tax, sheltering in-state rental income from state tax entirely (though Washington taxes certain capital gains).
Investors who own property in a different state than they live in must generally file a non-resident return in the state where the property sits, and then claim a credit for taxes paid to that state on their resident return to avoid double taxation. High-tax states can add 5% to 13% on top of the federal bill, materially changing the after-tax return on a sale. State treatment of depreciation, passive losses, and 1031 exchanges also varies — a few states have historically had clawback or reporting rules for deferred 1031 gains — so multi-state investors should model state tax alongside federal tax before selling.
Frequently asked questions
What taxes do I pay on rental income?
Rental income is taxed as ordinary income at your marginal federal rate. You also potentially owe state income tax and, if your modified AGI exceeds $200,000 (single)/$250,000 (MFJ), the 3.8% net investment income tax.
How is the sale of an investment property taxed?
The sale produces two types of gain: depreciation recapture (taxed at up to 25%) and capital gain on any appreciation above original cost (taxed at 0%, 15%, or 20% depending on income). Both may also be subject to the 3.8% NIIT.
Can I deduct rental losses against my wages?
Subject to passive activity rules. If your AGI is under $100,000, you can deduct up to $25,000 in rental losses against wages. This allowance phases out between $100,000 and $150,000 of AGI. Above $150,000, rental losses are generally suspended until you sell the property or have passive income.
Is depreciation on a rental property required?
You must take depreciation or lose the deduction benefit but still owe recapture tax. The IRS taxes you on depreciation 'allowed or allowable' — meaning even if you choose not to take it, you still owe recapture tax when you sell as if you had claimed it.
What is the depreciation schedule for a rental house?
Residential rental properties depreciate over 27.5 years using straight-line MACRS. Commercial rental properties use a 39-year schedule. Land is never depreciable.
How do I avoid paying taxes when I sell a rental property?
The most common tax-deferral tool is the 1031 exchange, which defers all gain by rolling proceeds into like-kind property. The primary residence exclusion (Section 121) may also apply if you convert the rental to a personal residence and meet the ownership and use tests.
Do I pay state income tax on investment property?
In most states, yes — rental income and sale gains are taxed at the state's ordinary rates, and many states do not offer a preferential capital gains rate. States with no broad income tax (Florida, Texas, Nevada, and others) shelter in-state rental income from state tax.
What is the QBI deduction for rental property?
Section 199A can allow a deduction of up to 20% of net rental income when the rental rises to a trade or business. A safe harbor in Rev. Proc. 2019-38 generally requires at least 250 hours of rental services and proper records.
Which is bigger, capital gains or depreciation recapture, when I sell?
For a long-held rental, accumulated depreciation recapture (taxed at up to 25%) is often the larger component, because decades of depreciation deductions can exceed the property's price appreciation above original cost.
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.