Capital Gains Tax On Rental Property

The taxable gain is the sale price minus the adjusted basis, and adjusted basis is not the same as what the owner paid at closing. Basis starts at purchase price plus closing costs and capital improvements, then gets reduced every year by the depreciation deduction claimed on the return, whether or not the owner actually used the deduction. That last part surprises a lot of first-time sellers: even a landlord who forgot to claim depreciation for a few years is still required to reduce basis as if they had, which the IRS calls allowed or allowable depreciation.

• Sale price minus selling costs equals amount realized
• Amount realized minus adjusted basis equals total gain
• Gain splits into a depreciation-recapture portion and a capital-gains portion
• Recapture is taxed at up to 25%, the remaining gain at long-term capital gains rates

The longer a property is held as a rental, the more depreciation has accumulated and the more basis has been ground down, which means a longer hold often produces a larger taxable gain relative to the original investment. This shows up constantly in submarkets like Hermitage and Antioch, where landlords who bought small multifamily properties fifteen or twenty years ago are now looking at sale prices several times their purchase cost, almost none of which is offset by remaining basis. The math rewards patience in appreciation but punishes it at the tax table unless the owner plans the exit deliberately.

Because rental property is held for investment, it generally qualifies for 1031 exchange treatment, which defers both the capital gains portion and the depreciation recapture portion of the tax by rolling the proceeds into replacement real estate rather than cashing out. This does not erase the gain; it carries the deferred amount forward into the new property's basis, and the tax becomes due again if that replacement property is eventually sold without another exchange. For a landlord tired of managing tenants directly, the proceeds can also move into a Delaware Statutory Trust interest as passive replacement property, which still satisfies the exchange requirement.

An owner who sells a fully depreciated Nashville rental with no deferral strategy in place can end up owing federal capital gains tax, depreciation recapture, and the 3.8% net investment income tax all in the same return, which on a six-figure gain adds up to a meaningful chunk of the sale proceeds. None of that changes what Tennessee charges at the state level, since the state does not tax capital gains, but the federal exposure alone is usually enough reason to at least evaluate a 1031 exchange or an installment sale before signing a listing agreement.

The timing matters as much as the strategy itself. A qualified intermediary has to be engaged before the sale closes, not after, and the identification and closing windows start running the day the relinquished property's sale is finalized. An owner who lists a Hermitage duplex without lining up a qualified intermediary in advance can lose the exchange option entirely the moment proceeds land in a personal account, even if the intent all along was to reinvest in another rental.

Some landlords reach a point where the tax deferral matters less than getting out of active management altogether. For those owners, a 1031 exchange into a Delaware Statutory Trust interest keeps the deferral benefit while removing tenant calls, lease renewals, and maintenance decisions from the picture entirely. This route comes with real tradeoffs, including illiquidity and limited control over the underlying asset, but it lets years of built-up Nashville rental equity keep working in real estate without another round of hands-on ownership.