Selling a Rental Property? 6 Ways to Keep More of the Gain
Selling an investment property can trigger four different taxes at once, and most owners plan for only one of them. The good news is that several legitimate strategies can defer, reduce or even eliminate the bill. Here is what you are really facing and the main ways to manage it.
Meet Dana*
Dana bought a rental in Orange County for $600,000 in 2015. She has taken $250,000 of depreciation, so her adjusted basis is $350,000. She sells for $1,200,000, net of selling costs. Her gain is $850,000.
A high-income seller like Dana can face roughly:
$62,500: federal tax on the $250,000 of depreciation recapture (unrecaptured §1250 gain), taxed up to 25%.
$120,000: federal tax on the remaining $600,000 of gain at 20%.
$32,300: the 3.8% net investment income tax on the full gain.
About $104,550: California, which taxes the whole gain as ordinary income at up to 12.3% (plus 1% above $1 million of income).
Total: about $319,000*, or roughly 38% of the gain.
Strategy 1: Defer it with a §1031 exchange
A like-kind exchange lets you roll the sale proceeds into another investment real property and defer both federal and California tax. The rules are strict:
Hand the proceeds to a qualified intermediary. If you touch the cash, the exchange fails.
Identify replacement property within 45 days of closing the sale, and close within 180 days.
Replace the value and the debt, or the shortfall (boot) is taxable.
Your depreciated basis carries over, so the deferred tax is still there when you eventually sell without exchanging.
California catch: if you exchange into property outside California, California keeps its claim on the deferred gain. You must file Form FTB 3840 for the exchange year and every later year until the gain is recognized, even if you no longer live here.
Strategy 2: Spread it with an installment sale
If you accept payments over several years, you generally report gain as you are paid (§453). That can keep you out of the top brackets and spread the NIIT. The unrecaptured depreciation gain is recognized first, and you carry the risk that the buyer defaults. Interest on the note is taxable too.
Strategy 3: Reinvest the gain in an Opportunity Zone
You can invest the gain in a qualified opportunity fund within 180 days. For new investments starting in 2027, the 2025 tax act makes the program permanent, gives a 10% basis step-up after five years (30% for qualified rural funds), and lets new appreciation be tax-free after ten years. The deferred gain itself is still taxed. California does not follow these rules, so California tax is due in the year of the sale either way.
Strategy 4: Give it away smartly
Donating appreciated property, or selling it inside a charitable remainder trust, can avoid or spread the gain while producing an income stream and a charitable deduction. It is the right tool if giving is already part of your plan, not a way to save tax on its own.
Strategy 5: Use losses and timing
Suspended passive losses from the property are generally released when you fully dispose of it, and can offset the gain.
Other losses from the same year, including stock losses, can offset capital gain.
Timing: a sale in a lower-income year, such as a sabbatical or early retirement, can drop some of the gain into a lower capital gains bracket. For 2026, the 0% rate applies up to $49,450 of taxable income (single) and the 15% rate up to $545,500.
NIIT: whether the 3.8% applies depends on whether the rental is a trade or business. It is worth checking before you assume it does.
Strategy 6: Hold until death
Heirs generally receive a stepped-up basis (§1014), which wipes out the gain and the depreciation recapture. With a $15 million federal estate tax exemption and no California estate tax, this can beat selling for many families. It is also the least flexible option: you give up the cash and keep the concentration risk.
Comparing the options
Where to start
Get your real number: adjusted basis, recapture, and state tax.
Decide whether you need the cash. If not, an exchange or an Opportunity Zone may fit. If so, an installment sale or timing may help.
Line up the intermediary and the advisors before you sign the sale contract. Most of these strategies cannot be added after closing.
*Illustration: single high-income seller, $850,000 gain including $250,000 depreciation recapture, 2026 federal rates, California at 12.3% on the full gain, other deductions ignored. Your numbers will differ. Not tax advice.
