Selling a rental property triggers two separate tax calculations layered on top of each other: the capital gains tax on the appreciation, and depreciation recapture on the depreciation claimed while the property was rented out. A landlord in Goleta or Carpinteria who has owned a duplex or small multifamily building for a decade or more is often surprised by how much of the sale proceeds those two calculations together claim, particularly if the property has been fully depreciated on paper.
How the Gain Is Calculated
Capital gain on a rental is the sale price minus selling costs minus adjusted basis, and adjusted basis is not simply the original purchase price. It is the purchase price plus capital improvements, minus total depreciation claimed over the holding period. Every year of depreciation deducted on the tax return lowers the basis, which raises the taxable gain at sale, even though no cash changed hands for that deduction along the way.
Federal Capital Gains Rates
If the rental was held longer than a year, the gain is taxed at long-term capital gains rates, either 0%, 15%, or 20% depending on the seller's total taxable income for the year of sale. High earners also owe the 3.8% net investment income tax on top of that rate. A seller near a bracket threshold can sometimes shift income or timing to land in a lower bracket, but the rate itself is set by total taxable income, not by anything specific to the property.
Depreciation Recapture Is a Separate Bill
The portion of gain attributable to depreciation already claimed, known as unrecaptured Section 1250 gain, is taxed separately at a rate up to 25%, not at the regular long-term capital gains rate. This applies regardless of how long the property was held, and it applies even if the property sold for less than what the owner originally paid, since recapture is based on depreciation taken, not on overall profit.
California Adds Its Own Layer
California does not have a separate capital gains rate. The state taxes the gain as ordinary income, with rates that reach 13.3% at the top bracket, on top of whatever federal tax applies. For a Santa Barbara landlord in a higher bracket, the combined federal and state bill on a rental sale can run well past a third of the total gain once recapture is included.
Deferring the Bill With a 1031 Exchange
Because a rental property is investment real estate, it qualifies for a Section 1031 exchange, which defers both the capital gains tax and the depreciation recapture by rolling the proceeds and the old basis into a replacement property. This does not erase the eventual tax; it postpones it and carries the built-in gain forward. Owners exiting management-heavy rentals along the South Coast frequently use this route to move into a lower-maintenance replacement, whether a net-lease property, a multifamily building in a different submarket, or a DST allocation, without paying tax on the transition.
Estimating the Bill Before Listing
A rough estimate before a rental goes on the market has to account for basis, recapture, and the applicable rate bracket separately, not as one blended number. Pulling the depreciation schedule from every year of ownership, along with records of capital improvements that raised the basis, is the starting point. A landlord who has owned a property since before switching accountants, or who inherited records from a prior owner's exchange, often finds the depreciation history is less complete than expected, and reconstructing it after the sale is harder than confirming it beforehand.
Capital Gains Tax Questions
Is depreciation recapture taxed the same as the capital gain on a rental sale?
No. The gain attributable to depreciation already claimed is taxed separately as unrecaptured Section 1250 gain, at a rate up to 25%, while the remaining gain is taxed at the applicable long-term capital gains rate.
Does California tax rental property capital gains differently than the federal government?
Yes. California has no separate lower rate for capital gains and taxes the gain as ordinary income, up to 13.3% at the top bracket, in addition to whatever federal capital gains and recapture tax applies.
How is adjusted basis different from the original purchase price on a rental?
Adjusted basis starts at the purchase price, adds capital improvements made during ownership, and subtracts every year of depreciation claimed. Total depreciation taken lowers the basis, which is why a long-held, fully depreciated rental often shows a larger taxable gain than the appreciation alone would suggest.
Can a 1031 exchange defer both the capital gains tax and depreciation recapture?
Yes, when structured correctly a 1031 exchange defers both the capital gains portion and the Section 1250 recapture portion by carrying the relinquished property's basis into the replacement property rather than triggering either tax at sale.
What if the rental sells for less than what was originally paid?
Depreciation recapture can still apply, because it is based on depreciation claimed rather than overall profit. An owner can owe recapture tax even on a sale that shows little or no gain above the original purchase price.
