Diane bought a single-family rental in 2014 for $280,000 and just accepted an offer for $450,000. Before signing, she did the estimate everyone does: gain is sale price minus purchase price, taxed at the 15% long-term capital gains rate. $170,000 × 15% = $25,500. Her actual federal tax bill came to $47,557 — $22,057 more, because that estimate only counts one of the three taxes a rental sale triggers.
Why the Naive Estimate Undercounts
Diane's math treats the entire $170,000 as capital gain. It isn't. Twelve years of depreciation lowered her taxable rental income every year she owned the property — and the IRS taxes that portion back separately when she sells, whether she claimed it or not. What's left over after that gets split again, this time by income level, into ordinary capital gains and a possible net investment income surcharge. Three layers, not one.
Layer 1: Depreciation Recapture
Diane allocated 80% of her $280,000 purchase price to the building ($224,000; land isn't depreciable). Residential rental property depreciates over 27.5 years straight-line:
$224,000 ÷ 27.5 = $8,145/year × 12 years = $97,745 in accumulated depreciation.
That $97,745 is taxed first, as "unrecaptured Section 1250 gain," at a rate capped at 25% — but the cap is a ceiling, not a flat rate. The IRS stacks it on top of a seller's other taxable income and runs it through the graduated brackets, charging 25% only on the slice that climbs above the top of the 24% bracket. Diane had $70,000 of other taxable income for the year; stacking $97,745 on top of that tops out at $167,745, which never reaches the 24%-bracket ceiling ($201,775 for a single filer in 2026). So none of her recapture hits the 25% cap — it's taxed at 22% and 24% instead, coming to $22,745, an effective 23.3% rate on the recaptured amount. Sellers with more other income, or a bigger recapture number, can and do hit the full 25%.
Layer 2: Ordinary Capital Gains on What's Left
After selling costs (7% of sale price, a standard closing-cost estimate) and recapture are separated out, here's the rest of the math:
| Sale price | $450,000 |
| − Selling costs (7%) | −$31,500 |
| − Adjusted basis ($280,000 − $97,745 depreciation) | −$182,255 |
| Total gain | $236,245 |
| − Depreciation recapture (taxed above) | −$97,745 |
| Remaining long-term capital gain | $138,500 |
With $70,000 of other income plus this $138,500 gain, Diane's income lands at $208,500 — inside the 15% long-term capital gains bracket (which runs through $545,500 for a single filer). $138,500 × 15% = $20,775.
Layer 3: The Net Investment Income Tax She Didn't Know Applied
NIIT is a flat 3.8% surcharge on investment income once modified AGI exceeds $200,000 (single) or $250,000 (married filing jointly). Diane's income plus her full $236,245 gain puts her MAGI at $306,245 — $106,245 over the threshold. NIIT applies to the smaller of her total gain or that overage, so: $106,245 × 3.8% = $4,037.
The Full Bill
| Layer | Tax |
|---|---|
| Depreciation recapture | $22,745 |
| Long-term capital gains | $20,775 |
| Net investment income tax | $4,037 |
| Total federal tax | $47,557 |
Against Diane's estimate of $25,500, that's $22,057 higher — the tax bill is nearly double what a straight "gain times 15%" calculation predicted, and the recapture layer alone very nearly equals her original full estimate.
What Actually Landed in Her Account
Net proceeds aren't sale price minus tax, either — selling costs come off first, and any remaining mortgage balance comes off after that. For Diane, with no mortgage left: $450,000 − $31,500 selling costs − $47,557 tax = $370,943 actually banked.
What This Doesn't Include
Every number above is federal only. State capital gains tax — which runs from 0% in states with no income tax up to 13.3% in California — is not included and can move the sell-side math substantially depending on where the property sits. This also assumes straight-line depreciation from Diane's basic inputs; a cost-segregation study, mid-year purchase conventions, or improvements added later would change the accumulated-depreciation figure and everything downstream of it.
Run Your Own Numbers
Diane's case uses a 12-year hold with straightforward numbers, but the three-layer stack applies to every rental sale — only the amounts shift. Put your own purchase price, hold period, and sale price through the Sell vs Keep Rental Calculator to see your actual recapture, capital gains, and NIIT exposure before you're staring at a closing statement.
Frequently Asked Questions
Does it matter whether Diane actually claimed depreciation on her tax returns every year?
No. The IRS taxes "allowed or allowable" depreciation — meaning the amount you were entitled to claim, whether you claimed it or not. A landlord who never took the deduction still owes recapture tax on it at sale, which is one of the more expensive tax mistakes to make twice.
Why didn't Diane's recapture hit the full 25% rate?
Because 25% is a ceiling, applied only to the portion of recaptured gain that would sit above the top of the 24% ordinary tax bracket once stacked on her other income. Sellers with less other income, or a smaller recapture amount, often see an effective rate well under 25% — sellers with more of either can hit it exactly.
Would a 1031 exchange have avoided all of this?
A 1031 exchange defers all three layers — recapture, capital gains, and NIIT — by rolling the proceeds into a new like-kind property instead of cashing out, but it comes with strict timing rules (45 days to identify a replacement, 180 to close) and doesn't eliminate the tax, only postpones it until the replacement property is eventually sold without another exchange.
Is the 7% selling-cost estimate realistic?
It's a reasonable planning estimate covering agent commissions, closing costs, and title fees, but actual costs vary by market and negotiation. Sellers close to a decision should get a real estimate from a title company or agent rather than relying on a round number.
Does this change if Diane still had a mortgage?
The tax calculation doesn't change — recapture, capital gains, and NIIT are all based on the sale price and basis, not on debt. What changes is net proceeds: any remaining mortgage balance comes directly out of what's left after tax, so a seller with a large balance can owe the same tax bill while walking away with far less cash.