Sell this rental in year 10 and $26,971 of the $140,836 goes to tax

A rental sale pays you twice. Cash arrives at closing, and a tax bill arrives the following April. The cash is simple arithmetic. The tax has two parts, and the first part catches people out, because it is a bill for deductions they already claimed and spent.

Here is the arithmetic on one house, with the IRS page that states each rule.

What does the sale put in your hand?

Start with the cash, because every tax figure is measured against it.

Take the rental calculator’s example house: $250,000, bought with 20% down on a 30-year loan at 7%, renting for $2,750 a month. Set the Hold period to 10 years and leave Selling costs at 7%. The projection carries the value forward at 3% growth a year while the loan is paid down.

These are example figures, not a forecast for any market.

So $140,836 lands in your account. Not one line above is a tax figure. The IRS taxes the gain, not what you receive, and the gain is measured from a number that ten years of depreciation deductions have been quietly shrinking.

What is depreciation recapture?

It is the part of your gain that exists because you took depreciation.

Every year you rent a property out, you deduct part of the building’s cost. Publication 527 then requires you to decrease your basis by “Depreciation you deducted or could have deducted on your tax returns under the method of depreciation you chose” (Publication 527, the edition for 2025 returns). Basis is the figure a gain is measured from. Ten years of deductions leave a smaller number to subtract from the sale price, so they leave a bigger gain.

Two rules then decide how that extra gain is taxed, and the order matters.

Residential rental property is depreciated on the straight line method. Publication 544 lists residential rental property placed in service after 1986 among the cases with no additional depreciation, because “These properties are depreciated using the straight-line method” (Publication 544, the edition for 2025 returns). Additional depreciation is what the section 1250 rules tax as ordinary income, so on a house bought this century there is usually none, and none of the gain turns into ordinary income on that account.

What the depreciation does become is unrecaptured section 1250 gain. IRS Topic 409 gives the rate: “The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate” (Topic no. 409, reviewed 24 September 2026). A maximum of 25%, not a flat 25%.

How big is the gain the IRS measures?

Gain is what you realized on the sale, less your adjusted basis.

The example assumes basis started at $257,500: the $250,000 price plus the 3% in buying costs, all of which the example treats as costs that belong in basis. Publication 527 lists which settlement fees go there, including legal fees, recording fees, surveys, transfer taxes and title insurance, and keeps others out, so a real closing statement has to be read line by line.

The example also assumes the county’s assessment puts 80% of the value in the building. That gives $206,000 to depreciate over 27.5 years, or $7,491 a year, and ten years of it comes to $74,909. A real first and last year are smaller: Publication 527 treats property placed in service, or disposed of, during a month as though that happened at the midpoint of the month.

Depreciation shows up as a plus below because it came off basis, and anything that comes off basis adds to the gain.

The gain is $129,870, against $140,836 of cash. Without the depreciation line it would be $54,961.

What is the tax on it?

The gain is taxed in two pieces, at two different rates.

The first $74,909 is the depreciation coming back, capped at 25%. The remaining $54,961 is long-term capital gain, because the house was held more than a year. Topic 409 puts it plainly: “Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term.” The same page sets the long-term rate at 0%, 15% or 20%, depending on your taxable income for the year.

The table below assumes the top of the recapture range and the middle capital gain rate.

That leaves $113,865 of the $140,836. The two rates are the example’s own assumption, and yours depend on your taxable income. Topic 409 also notes that individuals with significant investment income may owe the net investment income tax on top of the figures above.

What the arithmetic above leaves out

Four things, each able to move the answer by thousands of dollars.

State income tax, which Topic 409 does not cover.

A like-kind exchange. Section 1031 “applies only to exchanges of real property held for use in a trade or business or for investment”, and it defers the gain rather than cancelling it: the Form 8824 instructions say to report the deferred gain later “as if the exchange had been a sale”. The clocks are tight. Replacement property “must be identified within 45 days after the property being given up is transferred” and “must be received within 180 days, or by the due date of your tax return (including extensions), whichever is earlier” (Instructions for Form 8824, updated 30 April 2026).

Everything that changed your basis along the way, including improvements you capitalized.

The form. Publication 544 reports gain on the rental or business part of a property on Form 4797, not on the capital gain schedule by itself.

None of the calculators carry a tax line, so the cash-on-cash return and the ROI they show are pre-tax, and so is the 17.5% IRR this house earns over ten years.

Where to start on a house you already own

Find your depreciation total. It sits on the depreciation schedule filed with your return each year, and it sets the size of the 25% piece on its own.

Take that figure, your basis and a realistic sale price to a tax professional before you list the property, while a like-kind exchange is still available to you. If the house was once your home, renting it out or selling it walks through the three-year clock that decides whether the home sale exclusion still applies.