What Is Capital Gains Tax?
You sell real estate or stocks at a profit—you owe capital gains tax. How much? Depends on how long you held it. Short-term (one year or less) gets taxed as ordinary income—up to 37%. Long-term (over one year) gets the break: 0%, 15%, or 20%. Real estate adds a twist. Depreciation you claimed gets recaptured at 25% no matter your bracket. You can defer or cut the hit with a 1031 exchange, the primary residence exclusion, or opportunity zone investing.
Capital gains tax is the federal (and sometimes state) tax you owe when you sell an asset—like a rental property—for more than you paid for it.
At a Glance
- Short-term (held ≤1 year): taxed as ordinary income—10% to 37% depending on your bracket
- Long-term (held >1 year): 0%, 15%, or 20%—a big break if you're in a high bracket
- Depreciation recapture: the IRS claws back depreciation at a flat 25% when you sell rental property
- NIIT: high earners ($200K single, $250K MFJ) pay an extra 3.8% on investment income, pushing the top effective rate to 23.8%
- State taxes: nine states skip it; most others tax gains as ordinary income
How It Works
The holding period decides everything. Sell a flip in 11 months and your profit gets stacked onto your ordinary income—32% or 35% depending on your bracket. Hold that same property 13 months? You're in long-term territory. For 2025, single filers pay 0% on long-term gains up to $48,350 of taxable income, 15% from $48,351 to $533,400, and 20% above that. Married filing jointly? Double those thresholds. That's why buy-and-hold investors structure exits around the one-year mark.
Depreciation recapture is the gotcha. You've been deducting depreciation for years—maybe $8,000 a year on a $320,000 building. Sell, and the IRS doesn't let you keep it. They claw it back at 25%. Claimed $80,000 in depreciation over a decade? $80,000 of your gain gets hit at 25% before the rest gets the 0/15/20% treatment. Here's the kicker: recapture applies even if you never took the deduction. The IRS assumes you could have. You're paying back a benefit you might not have used. But if you deducted at 32% and pay back at 25%, you came out ahead.
The 3.8% NIIT stacks on. Once your modified adjusted gross income crosses $200,000 (single) or $250,000 (married), you owe an extra 3.8% on net investment income—including capital gains. That pushes your top long-term rate from 20% to 23.8%. On a $200,000 gain? That's $7,600 extra.
Real-World Example
Maria: flip vs hold.
Maria buys a Memphis duplex for $180,000, puts $40,000 into rehab, sells 10 months later for $265,000. Gain: $45,000. Short-term. It stacks onto her $95,000 W-2 income. She's at $140,000 taxable—22% bracket on the marginal dollars. Federal tax on that gain: $9,900. Plus state if she lives somewhere that taxes it.
Same deal, Maria holds 14 months. Long-term now. Her $45,000 gain gets the 15% rate—she's under the 20% threshold. Federal tax: $6,750. She saved $3,150 by waiting four months.
Jake: depreciation recapture bites.
Jake bought a $400,000 fourplex in 2015. He's claimed $120,000 in depreciation over nine years. He sells for $520,000. His total gain is $240,000. The first $120,000 is recapture—taxed at 25% = $30,000. The remaining $120,000 gets long-term rates. At 15%, that's $18,000. So Jake owes $48,000 in federal capital gains tax before state. A 1031 exchange would defer all of it.
Pros & Cons
- Long-term rates (0/15/20%) beat ordinary income for most investors—you keep more
- The primary residence exclusion ($250K single, $500K MFJ) wipes out gains entirely if you meet the two-year ownership and use tests
- 1031 exchanges let you defer gains indefinitely by rolling into replacement property
- Opportunity zones offer deferral plus potential exclusion of appreciation if you hold 10 years
- Depreciation recapture at 25% is often cheaper than the rate you deducted at—net benefit for high earners
- Short-term gains get hammered—no break, and you're stacking profit on top of regular income
- Depreciation recapture is mandatory; you can't opt out even if you didn't take the deduction
- State taxes add another layer—California tops out at 13.3% on top of federal. Ouch.
- The 3.8% NIIT hits high earners with no inflation adjustment to the thresholds
- Opportunity zone benefits are time-limited; deferred gains come due by December 31, 2026
Watch Out
Don't assume you're in the 0% bracket. A lot of investors think "I'll just stay under the limit." Your capital gain gets added to your other income. $40,000 W-2 plus a $50,000 long-term gain? You're at $90,000—well into the 15% zone.
Recapture isn't optional. Even if your CPA never filed depreciation, the IRS will impute it. You're paying 25% on the amount you could have deducted. No escape.
State residency matters. Sell a property in Texas (no state capital gains tax) while living in California? California taxes the gain. They want their 13.3%.
1031 timing is brutal. Miss the 45-day identification window or the 180-day closing deadline by one day and the whole exchange collapses. You owe the tax.
Ask an Investor
The Takeaway
Capital gains tax is the price of cashing out. Hold long enough for preferential rates. Plan for depreciation recapture. Use 1031 exchanges or the primary residence exclusion when they fit. High earners: factor in the 3.8% NIIT. Don't wing it—run the numbers before you list.