Sell a Rental: 3 Taxes That Hit a $400K Gain (2026)

Marcus, a single filer in Austin, Texas, bought a duplex for $300,000 in 2014, spent $50,000 on a new roof and kitchen renovation, and claimed $100,000 of depreciation over the years he rented it. In 2026 he sells for $650,000. He assumes his tax is “15% of the gain” — roughly $52,500. The actual federal bill is closer to $81,000, and for a higher-income seller it tops $100,000. The gap is the two taxes he forgot: depreciation recapture and the 3.8% NIIT. This article walks his exact numbers and shows you how to run yours.

Start with the number that drives everything: adjusted basis

You cannot compute the tax until you compute the gain, and you cannot compute the gain until you have your adjusted basis. This is the single number most sellers get wrong — usually by forgetting to subtract depreciation.

The formula (IRC §1011 and §1016):

Notice what depreciation did: it lowered his basis from $350,000 to $250,000, which increased his taxable gain by $100,000. The write-offs he enjoyed every year did not disappear — they were deferred to the day he sells. That deferred $100,000 is the recapture layer, and it is taxed differently than the rest of the gain.

One important trap: the IRS requires you to reduce basis by depreciation “allowed or allowable” (IRC §1250). If you should have claimed depreciation but never did, you still must subtract it. You get the worst of both worlds — no past deduction and a higher gain — so file Form 3115 to catch up missed depreciation before you sell.

Tax layer 1: Long-term capital gains on appreciation

Of Marcus’s $400,000 gain, $100,000 is recapture (covered next) and the remaining $300,000 is straight appreciation taxed at long-term capital-gains rates, because he held the property more than one year (IRC §1(h)).

The 2026 long-term capital-gains brackets:

A $400,000 gain stacks on top of your other income. Marcus has $90,000 of W-2 wages, so the gain pushes most of his taxable income into the 15% band, with the top slice crossing $533,400 into the 20% band. To keep the math clean, assume his $300,000 appreciation portion is taxed at a blended 15% → $45,000. (A higher-income seller with wages already above $533,400 would pay 20% on the whole appreciation slice — $60,000.)

Tax layer 2: Depreciation recapture (the up-to-25% surprise)

This is the layer that turns a “15% sale” into something far more expensive. The $100,000 of depreciation Marcus claimed is “unrecaptured §1250 gain,” and it is taxed at a maximum rate of 25% — not the 15–20% capital-gains rate (IRC §1250).

The logic: depreciation gave Marcus an ordinary deduction every year (worth up to 37 cents per dollar against his wages). When he sells, the IRS “recaptures” that benefit at up to 25% — a rate set between the ordinary and capital-gains rates. The recapture is computed first and fills the bottom of your gain stack:

• Recapture amount: the lesser of total depreciation claimed ($100,000) or your total gain ($400,000) → $100,000.
• Rate: taxed at your ordinary rate but capped at 25%. At Marcus’s income, the cap applies → 25%.
• Recapture tax: $100,000 × 25% = $25,000.

That $25,000 is more than half of what Marcus expected his entire tax bill to be. Depreciation is not free money — it is an interest-free loan from the IRS that comes due at sale.

Tax layer 3: The 3.8% Net Investment Income Tax

The third layer is the easiest to forget and applies to nearly every large rental sale. The NIIT (IRC §1411) adds 3.8% on the lesser of your net investment income or the amount your modified AGI exceeds $200,000 (single) or $250,000 (MFJ).

A $400,000 gain plus $90,000 in wages puts Marcus’s MAGI near $490,000 — roughly $290,000 over the $200,000 single threshold. The 3.8% applies to the lesser of his net investment income ($400,000 gain) or the amount his MAGI exceeds the threshold ($290,000). The smaller number controls, so the surtax is charged on $290,000, not the full gain:

• Lesser of $400,000 (net investment income) and $290,000 (MAGI over the $200,000 threshold) → $290,000.
• $290,000 × 3.8% = $11,020.

This stacks on top of the capital-gains and recapture taxes. A seller whose MAGI sits even further above the threshold would have the full $400,000 hit with the surtax ($15,200), because the net-investment-income figure would then be the lesser of the two. That is why the effective top federal rate on the appreciation portion of a rental sale is 23.8% (20% LTCG + 3.8% NIIT), and recapture can effectively approach 28.8% (25% + 3.8%).

Putting all three together on the $400K gain

Marcus expected $52,500. The real federal number is $81,020 — and if his wages had been high enough to push the appreciation into the 20% bracket and the full gain into NIIT, it would top $100,000 ($60,000 + $25,000 + $15,200). The two layers he ignored (recapture and NIIT) added $36,020 to a bill he thought was a simple 15% calculation. He lives in Texas, so there is no state income tax; an owner in California (13.3% top rate) or New York (10.9%) would owe tens of thousands more, because most states tax the gain as ordinary income with no preferential rate — California alone could add roughly $53,000 on a $400,000 gain.

Short-term vs long-term: the one-year cliff

Everything above assumes Marcus held the duplex more than one year. If he had owned it one year or less, the entire $400,000 gain would be short-term — taxed as ordinary income at rates up to 37% (IRC §1(h)), with no 0/15/20% preferential rate and no separate recapture treatment. On a $400,000 short-term gain, a top-bracket seller could owe roughly $148,000 in federal income tax plus the 3.8% NIIT. The one-year holding line is one of the most expensive dates in real-estate investing — count from the day after you acquired the property.

What most people miss: the basis errors that inflate the bill

The three taxes are mechanical once you have the right basis. The mistakes happen before the rate even applies:

• Forgetting to add capital improvements. The new roof, the HVAC replacement, the kitchen remodel — these add to basis and shrink your gain. Repairs do not (they were already deducted). Marcus’s $50,000 of improvements saved him roughly $12,000 in tax. Keep every receipt.
• Forgetting that depreciation reduces basis whether you claimed it or not. The “allowed or allowable” rule (IRC §1250) means the IRS assumes you took the depreciation. If you never did, fix it with Form 3115 before selling so you at least capture the past deductions.
• Missing the §121 home-sale exclusion overlap. If you lived in the property as your primary home for 2 of the last 5 years before converting it to a rental, you may shelter up to $250,000 (single) / $500,000 (MFJ) of the appreciation under IRC §121 — but recapture is never excluded. That depreciation always comes back.
• Ignoring selling costs. Real-estate commissions, transfer taxes, and closing costs reduce your amount realized and therefore your gain. A 6% commission on a $650,000 sale is $39,000 that comes straight off the top.

The decision: pay the $81,020 now, or defer it

Once you know the number, the real choice is whether to write the check this year or use one of three legal levers to defer or eliminate it. Each one is a full topic of its own — the point here is to know they exist before you sign a listing agreement:

1. 1031 like-kind exchange (IRC §1031). Roll the entire $650,000 into a replacement rental and defer all three taxes — capital gains, recapture, and NIIT — until you sell the replacement. You must identify the new property within 45 days and close within 180 days, using a qualified intermediary who holds the proceeds. This is the most powerful deferral if you want to stay invested in real estate.
2. Installment sale (IRC §453). Sell on terms and collect the price over several years. You spread the gain across tax years, which can keep your taxable income under the $533,400 (single) 20%-LTCG threshold and below the NIIT cliff in any single year. Note: depreciation recapture is taxed in full in the year of sale even on an installment basis — only the capital-gain portion spreads.
3. Hold until death for a step-up (IRC §1014). If you never sell, your heirs inherit the property at its date-of-death fair market value. The entire $400,000 gain — appreciation and recapture — vanishes. This is the “buy, borrow, die” endgame; in community-property states a surviving spouse can get a full step-up on the whole property.

The decision lever is timeline and intent: if you want to stay in real estate, run a 1031 and defer everything; if you want out but can tolerate payments over time, an installment sale smooths the brackets and shaves the NIIT; if the property is a legacy asset you do not need to liquidate, holding for the step-up erases the bill entirely. The wrong move is selling outright in a single year without modeling which lever keeps the most dollars in your hands — run your own basis and gain through the comparison before you list.

Key takeaways

• Three taxes stack on a rental sale: long-term capital gains (0/15/20%), depreciation recapture (up to 25% on unrecaptured §1250 gain), and the 3.8% NIIT above $200K single / $250K MFJ MAGI. On a $400,000 gain with $100,000 of recapture, federal tax commonly runs $81,000–$100,000-plus before any state tax.
• Adjusted basis = purchase price + capital improvements − depreciation claimed (IRC §1011, §1016). Forgetting to subtract depreciation is the most common error — and the IRS subtracts it whether you claimed it or not.
• Depreciation recapture is the surprise layer. It is taxed at up to 25%, higher than the capital-gains rate, and it is never excludable — not even under the §121 primary-residence exclusion.
• The effective top federal rate is 23.8% on appreciation (20% + 3.8% NIIT) and approaches 28.8% on recapture. Held one year or less, the whole gain is ordinary income up to 37%.
• Three deferral levers: a 1031 exchange defers all three taxes, an installment sale spreads the capital-gain portion across years, and holding until death gives heirs a stepped-up basis that erases the gain. Model your own numbers before you list.