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Selling a rental property: the recapture surprise, and five ways out

Depreciation recapture is the tax landlords discover on the closing statement. Here is what a typical 20-year rental costs to sell, and what each strategy does and does not fix.

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What this sale costs if nothing is planned

Rental bought for $400,000, depreciated $250,000, sold for $1,200,000, married couple, California, 2026

Layer	Rate (source below)	Amount
Depreciation recapture (unrecaptured 1250)	up to 25%	about $62,000
Long-term capital gain (about $800K)	15% / 20%	about $140,000
Net investment income tax	3.8% on the gain	about $40,000
California (whole gain, recapture included)	9.3% to 12.3%	about $105,000
Total		about $347,000 (43% of gain)

Rounded, illustrative, assumes no other income in the year of sale. See Sources and review at the bottom of the page.

The options, in plain language

Five ways this tax gets paid, spread or shrunk

1031 exchange. Defers everything including recapture. 45 days to identify, 180 to close, qualified intermediary. You stay a landlord. CA tracks out-of-state exchanges.
Delaware Statutory Trust. A 1031 into a passive fractional interest. No management, same deferral, but 5 to 10 years illiquid and 8% to 12% fees. Read the PPM.
Section 453 installment sale. Sell outright, take the price over time (seller note or structured sale). Spreads the capital gain; recapture still year one. You are done.
Charitable remainder trust. Deed the property to the trust first; it sells untaxed, pays you 5%+ for life, deduction now. Irrevocable.
Sell and pay in the right year. Retire first, close in January, harvest losses, split across two years. Often cheapest under $500K of gain.

Who this is written for: people who have owned the asset for years, often decades, and are selling once, usually around retirement. If you are buying and selling frequently, different rules (dealer status, ordinary income) apply and this page is not for you.

Six questions to bring to your CPA

How much depreciation have I taken, including any I should have taken?
What is the recapture number by itself?
Does NIIT apply this year, and would a two-year split avoid it?
If I 1031, what happens to the tax if I die owning the new property?
Was this ever my primary residence (Section 121 overlap)?
What does California do if I exchange into Texas?

The deadlines that decide it

1031: 45-day identification, 180-day close, both from the sale closing date.
Installment: terms in the contract before closing.
CRT: deed before a binding sale agreement.
Estimated tax in the quarter of the sale.

Common questions

Straight answers

Does a 1031 defer depreciation recapture?

Yes, a full exchange defers all of it. An installment sale does not.

I lived in it before renting it out. Does the $500K exclusion apply?

If you lived there 2 of the last 5 years, yes on the gain, but not on depreciation taken after May 1997. You can combine 121 and 1031.

What if I owner-finance the buyer?

That is an installment sale. The gain is taxed as principal arrives; interest is ordinary income.

Can I 1031 into a Delaware statutory trust and later into my own property?

Yes, Delaware statutory trusts are 1031-eligible on the way in and out, subject to the sponsor's timeline.

Audit trail

Sources and review

Reviewed for the Retirement Literacy Foundation, a 501(c)(3) education nonprofit. Prepared by Hans Goldstein, retirement educator; IRS Special Enrollment Examination Parts 1, 2 and 3 passed, enrollment pending; California licensed insurance professional #4273294. Informational only. Not tax, legal or investment advice. Every figure below cites its source so your CPA or attorney can check it.

Capital gains rates and brackets 2026: IRS Rev. Proc. 2025-32 (2026 inflation adjustments); IRC 1(h)
Net investment income tax 3.8%: IRC 1411; thresholds $200,000 single / $250,000 MFJ, not indexed
Depreciation recapture 25% (unrecaptured 1250) and 1245: IRC 1(h)(6), IRC 1245, IRC 1250; IRS Pub. 544
Section 121 home-sale exclusion: IRC 121; IRS Pub. 523; surviving-spouse 2-year rule IRC 121(b)(4)
1031 exchange rules: IRC 1031 (real property only after TCJA 2017); Treas. Reg. 1.1031(k)-1 (45/180 days, QI); IRS Form 8824
Delaware Statutory Trust as 1031 property: IRS Rev. Rul. 2004-86
Installment sales: IRC 453; IRS Pub. 537; Form 6252; IRC 453A interest charge above $5,000,000; IRC 453(k) excludes publicly traded stock
Monetized installment sales: IRS Dirty Dozen (IR-2023-54 and later); proposed regs REG-109348-22
QSBS: IRC 1202 as amended by P.L. 119-21 (2025): $15M cap, tiered holding periods for stock issued after July 4, 2025
Charitable remainder trusts: IRC 664; Treas. Reg. 1.664; pre-arranged sale doctrine (Rev. Rul. 78-197)
Step-up in basis: IRC 1014; community property IRC 1014(b)(6)
Inherited IRA 10-year rule: IRC 401(a)(9)(H) (SECURE Act); Treas. Reg. 1.401(a)(9) final regs 2024
California treatment: Cal. Rev. & Tax. Code 17041 (rates), 18031 (1031 conformity), FTB Form 3840 (out-of-state exchange tracking); Prop 19 (Cal. Const. art. XIII A, sec. 2.1)
Purchase price allocation: IRC 1060; IRS Form 8594

Figures are 2026 federal amounts and 2025 California rates unless stated. Examples are illustrative, rounded, and assume no other income; your numbers will differ. Last reviewed September 21, 2026.

Selling a rental property: the recapture surprise, and five ways out

What this sale costs if nothing is planned

Five ways this tax gets paid, spread or shrunk

Six questions to bring to your CPA

The deadlines that decide it

Straight answers

Does a 1031 defer depreciation recapture?

I lived in it before renting it out. Does the $500K exclusion apply?

What if I owner-finance the buyer?

Can I 1031 into a Delaware statutory trust and later into my own property?

Sources and review

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