Your Rental Sold for $420,000. Four Tax Layers Later, You Kept $297,000.
Most landlords discover their full tax liability at filing. By then it’s too late to change the decision.
My friend called me in March. He had just left his accountant’s office. He’d sold his rental property the previous fall - bought for $200,000 fifteen years ago, appreciated to $420,000, clean exit. He felt good about it.
Then he saw what he owed.
“I knew I’d owe capital gains,” he said. “I didn’t know it would be this much.”
When he filed his return, he owed just over $98,000.
On a $420,000 sale. After the 6% sales commission ($25,200) and the tax liability ($98,000), he walked away with about $297,000.
Many people miss this gap between closing day and tax day. You sell, you feel the win, and months later you’re sitting with your accountant realizing what you actually owe. Most people don’t work it out before they sign the closing documents. They discover it retroactively, at tax time.
He knew about capital gains tax. What he hadn’t worked out - what many people don’t work out until that accountant appointment - were the three other taxes stacked underneath it. Here’s what the full liability looked like.
Layer 1: Long-term capital gains tax. $30,160.
This is the one people know about. But the taxable gain isn’t simply sale price minus purchase price. The IRS lets you add to your cost basis: closing costs at purchase, capital improvements made over the years, and selling costs reduce what you’re taxed on. He bought for $200,000. Add $4,000 in closing costs and $40,000 in capital improvements over fifteen years - adjusted cost basis of $244,000. The $25,200 sales commission reduces the amount realized. That brings the taxable long-term capital gain to $150,800. At the top federal rate of 20%, the federal capital gains tax is $30,160.
It’s also the most familiar - and for many people, the only layer they budget for.
Layer 2: Depreciation recapture. $27,818.
This is the one that catches people off guard.
Every year you own a rental property, the IRS requires you to depreciate it - deducting a portion of the structure’s (the building itself, not the land it sits on) value against your rental income each year. The depreciable basis is the structure only. On a $200,000 property with a typical 80/20 structure-to-land split, that’s $160,000 - plus the $4,000 closing costs and $40,000 in capital improvements, which are also fully depreciable. Total depreciable basis: $204,000. Depreciated over 27.5 years, that’s $7,418 per year. Over fifteen years, total depreciation taken: $111,273.
Those deductions reduced his taxable income every year he held the property. On the back end, when he sold, the IRS recaptured every dollar. Depreciation recapture is taxed as ordinary income but capped at 25% under Section 1250 - so even if your ordinary income rate is higher, the recapture portion tops out there. $111,273 at 25% is $27,818.
One more wrinkle: if you used an accelerated depreciation method rather than straight-line, the portion exceeding straight-line is taxed at your ordinary income rate - which can reach 37% - not the 25% cap. Worth confirming with your CPA which method was applied to your returns.
Worth flagging with your CPA: if you never actually claimed depreciation deductions over the years - some landlords don’t realize they’re entitled to them - that may not protect you from recapture tax at sale. The IRS position on this is worth understanding before you close.
Layer 3: Net Investment Income Tax. $9,959.
The Net Investment Income Tax is a 3.8% surtax on investment income - including capital gains from rental property sales - for taxpayers above $200,000 in modified adjusted gross income (single) or $250,000 (married filing jointly) in 2025. Many high earners clear this threshold. Many don’t know this tax exists until they see it on their return.
It applies to the full taxable gain: the $150,800 capital gain plus the $111,273 depreciation recapture. That’s $262,073 in total gain, times 3.8%, equals $9,959. It’s the smallest of the four layers but it’s pure addition - no deductions, no offsets, just a surcharge on top of everything else.
Layer 4: State and local taxes. $30,007.
Federal taxes are only part of the liability. Most states tax capital gains, and many tax them as ordinary income rather than at a preferential rate. In his state and county, the combined rate came to over 11% - adding $30,007 to the total.
That number swings dramatically by location. A landlord in Texas or Florida owes zero state tax on the same sale. A landlord in California faces a state rate of up to 13.3% - on the $262,073 gain in this example, that’s roughly $35,000 more out of pocket than a no-tax state. Where you own the property is a tax decision whether you thought of it that way or not.
The full picture.
Add it up: $97,944 in total tax liability, plus $25,200 in sales commission. He sold for $420,000 and walked away with about $297,000. That’s the number that matters. What he wished he'd done: work out the full picture with his CPA before listing, not after filing.
That $98,000 is before any offsets. Two things can soften it if you have them. Suspended passive losses accumulated over the years - unusable against W2 income - are fully released at sale and apply directly against the gain. Capital loss carryovers from other investments, which the IRS otherwise limits to $3,000 a year against ordinary income, can be applied in full here. Neither is a given. In his case, any accumulated losses would have applied directly here - a rental sale is when they finally become useful.
The property performed exactly as it should have. Fifteen years of appreciation, tenants who paid the mortgage, a clean exit at a gain. Nothing went wrong.
But had he worked out the full picture before listing - commission, tax liability across all four layers, net proceeds - the decision might have looked different. Keep and hold. 1031 into something larger. Sell and take the liquidity. Those are three different answers depending on the number in front of you. He never ran it before he signed.
One thing he flagged for anyone in the same position: if you don't plan for the liability in the quarter you close, your regular withholding may not cover it - and an underpayment penalty is the last surprise you want after a clean exit.
Have you worked out the full after-tax picture with your CPA before deciding to sell a rental property? Most people haven’t - they discover what they owe retroactively, at tax time, when it’s too late to change the decision. Hit reply and tell me where you are in that process.
I am not a financial advisor. Nothing in this newsletter is investment or tax advice. This post walks through one illustrative example. Your situation will differ significantly. Tax rules are complex, vary by situation, and change over time - consult your CPA before making any decisions. Fine Print Investing publishes weekly.