How to Tax Long Term Real Estate Capital Gains

When you sell real estate for more than you paid, the profit is a capital gain. If you owned the property for more than one year, it qualifies as a long-term capital gain, which is subject to different tax rules and often lower tax rates than regular income.

Calculating Your Real Estate Capital Gain

To calculate your capital gain, subtract the property’s adjusted basis from its selling price. The details within each part of this formula are important for accuracy.

The selling price is the gross sale price of the property reduced by any selling expenses you incurred. Deductible expenses include real estate agent commissions, legal fees, advertising costs, and other closing costs paid by the seller. Subtracting these expenses from the gross price gives you the “amount realized” from the sale.

The property’s adjusted basis starts with the initial basis—what you originally paid for the property, including closing costs like title insurance. This initial basis is then increased by the cost of any capital improvements made during your ownership. A capital improvement adds value to the property, prolongs its life, or adapts it to new uses, such as adding a room or replacing the entire roof.

It is important to distinguish between a capital improvement and a simple repair. Repairs, like painting a room or fixing a leak, are considered maintenance and do not increase your basis. For example, replacing a single shingle is a repair, but replacing the entire roof is an improvement. You must keep records and receipts for all capital improvements to substantiate these increases to your basis.

Certain events can decrease your basis. For rental or business properties, the most significant decrease comes from depreciation deductions you claimed on your tax returns. Other decreases can include casualty loss deductions you’ve taken due to events like fires or storms, or tax credits received for energy-efficient home improvements. The final figure, after all these adjustments, is your adjusted basis.

Determining the Applicable Tax Rates

Federal long-term capital gains have lower tax rates than ordinary income. The rates are 0%, 15%, or 20%, and the specific rate you pay depends on your total taxable income and filing status.

For the 2025 tax year, a single filer with a total taxable income up to $48,350 would fall into the 0% bracket for their long-term capital gains. The 15% rate applies to those with income between $48,351 and $533,400, and the 20% rate applies to income above that amount. For those married filing jointly, the 0% bracket extends up to $96,700 of taxable income, the 15% rate applies to income between $96,701 and $600,050, and the 20% rate applies above that threshold. These income thresholds are indexed for inflation.

Some taxpayers may also be subject to an additional 3.8% Net Investment Income Tax (NIIT). This surtax applies to individuals, estates, and trusts with income above certain thresholds. For 2025, the NIIT applies if your modified adjusted gross income (MAGI) exceeds $200,000 for single filers or $250,000 for those married filing jointly. The tax is applied to the lesser of your net investment income or the amount your MAGI exceeds the threshold.

Federal taxes are only part of the picture, as most states levy their own taxes on capital gains. The methods and rates vary widely; some states tax capital gains as ordinary income, while others have a lower flat tax rate. You must consult your state’s tax regulations to understand your total liability.

Exclusions and Deferral Strategies

Several strategies can reduce or postpone the tax bill on a real estate sale. The most common are the primary residence exclusion for homeowners and the 1031 exchange for investors.

For individuals selling their main home, the Section 121 exclusion allows you to exclude a substantial amount of gain from your income. This is up to $250,000 for a single filer and up to $500,000 for a married couple filing a joint return. To qualify, you must have owned the property and used it as your principal residence for at least two of the five years preceding the sale.

The two years for the ownership and use tests do not need to be continuous. For instance, you could live in the home for 18 months, rent it out for two years, and then move back in for another six months to meet the use test.

For investors who own rental or business property, the 1031 exchange is a tax-deferral strategy. This is not a tax exclusion but a method to postpone paying taxes on the gain. The principle of a 1031 exchange is that you sell one investment property and reinvest the proceeds into another “like-kind” investment property, rolling the gain forward.

The rules for a 1031 exchange are strict regarding the timeline. From the day you close the sale of your original property, you have 45 days to formally identify potential replacement properties in writing to a qualified intermediary. You then have a total of 180 days from the original sale date to close on the purchase of one or more of the identified properties. Missing either deadline will disqualify the transaction, making your gain immediately taxable.

An installment sale can be used for any property sale where you receive at least one payment after the tax year of the sale. Instead of recognizing the entire gain in the year of the sale, you report a portion of the gain each year as you receive payments. This can spread the tax liability over several years and potentially keep you in a lower capital gains tax bracket.

Reporting the Sale on Your Tax Return

After closing, the responsible party, like a title company, will issue Form 1099-S, Proceeds From Real Estate Transactions, to you and the IRS. This form reports the gross proceeds from the sale and alerts the IRS to the transaction; it does not show your calculated gain or loss. You may still need to report the sale even if you can exclude the entire gain, especially if you receive a Form 1099-S.

The detailed calculation of your gain or loss is reported on Form 8949, Sales and Other Dispositions of Capital Assets. On this form, you will list the property’s description, acquisition and sale dates, the sale proceeds, and your adjusted basis. This form is also where you enter codes for adjustments, like claiming the primary residence exclusion.

The totals from Form 8949 are transferred to Schedule D, Capital Gains and Losses, which summarizes all your capital asset transactions for the year. Schedule D separates transactions into short-term and long-term categories and combines your real estate gain with any other capital gains or losses. The final net gain or loss from Schedule D is then carried over to your Form 1040 and included in your overall income calculation.