Rental Property in Retirement: Capital Gains Tax, Recapture and Whether to Sell

It can be, but judge it the way you would judge any other holding: by what it pays after expenses relative to what you could sell it for today, not relative to what you paid. A house bought for $300,000 in 2008 that now rents for $3,100 a month feels like a strong investment. If it is worth $750,000 and nets $21,000 a year after property tax, insurance and repairs, it yields 2.8% on today's value. Rents usually rise with inflation, which a bond does not offer, and the house may keep appreciating. Against that: the income comes from one building in one town, a vacancy or a new roof can take a year's profit, and you cannot sell 4% of a house to fund a year of spending.

For tax, rent is ordinary income, reported with its expenses on Schedule E (IRS Publication 527). You deduct mortgage interest, property tax, insurance, repairs, management fees and travel to the property, plus depreciation. A residential rental building is depreciated over 27.5 years on a straight-line schedule; the land under it is never depreciated. On a $240,000 building, that is about $8,727 a year of deduction with no cash going out. Depreciation is the reason a rental with healthy cash flow often shows little taxable profit. It is also the source of the recapture tax when you sell.

Net rental income counts as investment income for the 3.8% net investment income tax, which applies to the smaller of that income or modified AGI above $250,000 for a joint return ($200,000 single) (IRS Topic 559). Most retirees are below those lines in an ordinary year and well above them in the year they sell. Rental income also counts toward the income that makes Social Security taxable and toward Medicare's income-related premiums, covered in our guide to taxes in retirement.

To see what a property really returns, including appreciation and the cost of leverage if you still have a mortgage, run it through our rental property ROI calculatorusing today's value as the investment.

Rental losses are passive, so as a rule they can offset only passive income, and unused losses carry forward. The main exception is a special allowance: if you actively participate, meaning you make management decisions such as approving tenants, setting rents and approving repairs, you can deduct up to $25,000 of rental losses a year against other income. The allowance shrinks by 50 cents for each dollar of modified AGI above $100,000 and is gone at $150,000 (IRS Publication 925). You must own at least 10% of the property to actively participate (26 U.S.C. 469(i)(6)).

A couple with MAGI of $130,000 and a $20,000 rental loss has an allowance of $10,000, so $10,000 is deducted this year and $10,000 is suspended. Many affluent retirees are above $150,000 once IRA distributions and Social Security are counted, so for them the allowance is zero and losses simply accumulate.

Suspended losses are not lost. When you sell your entire interest to an unrelated buyer in a fully taxable sale, all of the accumulated losses become deductible against any income that year (26 U.S.C. 469(g)). At death, they are deductible on the final return only to the extent they exceed the step-up in basis, so a long-held, appreciated rental can take its suspended losses to the grave. That is one reason to keep a clear record of carryforwards: they can shelter a large part of a sale.

Two other rules matter more in retirement than before it. First, a real estate professional is not subject to the passive rules. The test requires more than 750 hours a year in real property businesses where you materially participate and more than half of all your working hours; on a joint return, one spouse must meet it alone (IRS Publication 925). The half-your-hours test is easier once you have stopped working elsewhere, but 750 hours is about 15 hours a week, documented. Second, a property with an average guest stay of seven days or less, such as a short-term vacation rental, is not a rental activity under these rules at all; whether its losses are passive depends on whether you materially participate.

Start with the gain: the sale price minus selling costs, minus your adjusted basis. Adjusted basis is what you paid, plus improvements such as a new roof or kitchen, minus every dollar of depreciation you were allowed to take. The IRS reduces basis by depreciation you could have claimed even if you did not claim it (IRS Publication 527). The sale is reported on Form 4797, and for residential rental property depreciated on the normal straight-line schedule there is no additional ordinary-income recapture (IRS Publication 544). The gain is then taxed in layers:

The recapture layer is the one most summaries get wrong. Topic 409 describes it as taxed at "a maximum 25% rate" (IRS Topic 409). The tax code stacks it after your ordinary income and taxes whatever falls in the brackets below 25% at those bracket rates (26 U.S.C. 1(h)(1)). A married couple in 2026 pays the full 25% only on recapture above $403,550 of taxable income. For most retirees the recapture rate is 22% or 24%. The appreciation layer comes last, which is why a large sale pushes most of it into the 15% and 20% brackets.

Holding matters too. A property held one year or less produces short-term gain, taxed entirely at ordinary rates (IRS Topic 409). Capital losses elsewhere in your portfolio offset the gain dollar for dollar, so a sale year is a good year to realize losses you have been carrying.

They turn on how many days you rent it at a fair price and how many days you use it yourself. If you rent a home you also use for fewer than 15 days in the year, the rent is tax-free and you deduct no rental expenses. Beyond that, the home is treated as your residence if your personal use is more than the greater of 14 days or 10% of the days it is rented at a fair price (IRS Publication 527). Personal use includes days used by you, your family or a co-owner, and days rented to anyone below a fair rent. Days spent mainly on repairs do not count.

The second-home owner who spends two months at the lake and rents it for six weeks is in the third row: the rent is taxable but there is no loss to deduct. The owner who visits for ten days and rents it for twenty weeks is in the second row and runs the place as a business. Neither kind of home qualifies for the home-sale exclusion unless it was your main home for two of the last five years, and a home used mainly for personal purposes cannot be exchanged under section 1031.

You can, but for a long-held rental it saves far less than the popular advice suggests. The exclusion of up to $250,000 of gain, or $500,000 on a joint return, requires that you owned the home and lived in it as your main home for at least two of the five years before the sale (IRS Publication 523). Since 2009, however, gain allocated to periods when the property was not your main home, called nonqualified use, cannot be excluded. The allocation is by time: nonqualified use after 2008 divided by total ownership. Time after you last lived there, within the five-year window, does not count against you. And depreciation claimed after May 6, 1997 is taxable no matter what.

Suppose Walt and June, from the example below, move into their rental in 2027, live there two years, and sell in early 2029 for the same price. They owned it 21 years; 18 of those, 2009 through 2026, were nonqualified rental use. The $165,000 of depreciation is taxable. Of the other $405,000 of gain, 18/21 or $347,143 is allocated to nonqualified use and stays taxable. Only $57,857 is excluded, in exchange for two years of living in a house they may not want.

The move-in approach works in the other direction: a home that was your main home first and then rented keeps its full exclusion if you sell within three years of moving out. If you are thinking about selling your own house and keeping a rental, or the reverse, our guide to downsizing in retirement works through the home-sale exclusion and moving costs.

Illustrative example: the people and figures below are hypothetical, not real clients. Numbers are calculated from the stated assumptions.

Walt is 68 and June is 66. They file jointly. In 2008 they bought a rental house for $300,000; their CPA allocated $60,000 to land and $240,000 to the building. It is paid off and worth about $750,000. It rents for $3,100 a month, $37,200 a year; property tax, insurance, repairs and other costs come to $16,200, leaving $21,000 of cash flow. After $8,727 of depreciation, Schedule E shows $12,273 of profit. Their other 2026 income: $58,000 of Social Security, a $24,000 pension, $30,000 of IRA withdrawals, $4,000 of interest and $8,000 of qualified dividends. Their AGI is $127,573 and their federal income tax about $8,153.

The sale costs them about $118,197 of federal tax, 21% of the gain, plus $12,710 of Medicare surcharges two years later. Notice where the rates land. Their recapture is taxed at 12%, 22% and 24%, not 25%, because it fills the brackets above their ordinary income. The appreciation sits on top, mostly at 15% with the last slice at 20%. The 3.8% surtax applies to most of the gain: to all income above $250,000 of MAGI.

Keep. The rent adds only about $1,473 to their federal tax, because depreciation shelters much of it and they are in the 12% bracket, so the house nets about $19,527 a year after tax. The depreciation schedule runs out around 2035, after which more of the rent is taxable. If they sold and invested $574,093, a 4% withdrawal would give about $22,964 a year, similar income without the tenants, but they would have paid the tax to get there.

1031 exchange. Exchanging into another investment property keeps all $705,000 working and defers the $130,907 of tax and surcharges. At 4%, that deferred amount is worth about $5,236 a year of income. The basis carries over, so the gain is waiting inside the new property.

Installment sale. Selling with 20% down and the rest in 10 annual payments, they recognize 76% of each principal payment as gain. The first-year gain of $114,000 is all recapture, adding $25,825 of tax and a first-tier IRMAA year ($2,297); later years add about $4,767 each. Total federal tax over the 11 years is about $78,345 at 2026 rules, against $118,197 for a lump sale, mainly because they stay below the NIIT and 20% lines. They also receive interest, which is taxable, and they take the risk that the buyer stops paying.

Hold for heirs. If they keep the house, the gain is never taxed. In a common-law state, owning it as joint tenants, the survivor's basis after the first death becomes about $442,500 (half the old basis plus half the value); in a community-property state, the whole property steps up to about $750,000. At the second death the children inherit at full value. The $165,000 of depreciation is never recaptured.

Their answer depends on things the arithmetic cannot settle. If they are healthy, the property is easy to manage and their children want it, holding is hard to beat. If the landlord work is wearing on them, an exchange into a property someone else manages, or a sale in installments, softens the tax. If they need the money for a move or for care, selling and paying the tax is a reasonable price for simplicity. For a charitable household, a charitable remainder trust can sell the property without immediate tax and pay them income for life.

The same way at 70 as at 40, with the added fact that it can be the bridge to a step-up. Since 2018, section 1031 applies only to real property held for investment or business use, and US real property is not like-kind to foreign property (IRS). The deadlines are strict: you have 45 days after selling to identify replacement properties in writing, and you must close within 180 days or by your tax return's due date, with extensions, whichever is earlier. You cannot touch the proceeds; a qualified intermediary holds them, and your own agent, attorney or accountant cannot serve (IRS FS-2008-18). Cash you take out, called boot, is taxable, and the exchange is reported on Form 8824.

The gain is deferred, not forgiven. Your old basis carries into the new property. That is why an exchange late in life is often a step toward holding until death: the deferral becomes permanent when heirs take a stepped-up basis. For a retiree who wants the tax deferral but not the tenants, the usual answer is a replacement property with a long-term net lease or a fractional interest such as a Delaware statutory trust. Those trade the landlord work for sponsor fees, limited liquidity and little control, so ask how the person recommending one is paid.

Related-party exchanges carry a two-year rule: if you or the related party disposes of the property within two years, the deferred gain comes due (Form 8824 instructions). And a vacation home qualifies only if it meets the rental safe harbor in Revenue Procedure 2008-16: owned 24 months before the exchange, and in each of the two 12-month periods rented at a fair rental for at least 14 days with personal use no more than the greater of 14 days or 10% of rented days (Rev. Proc. 2008-16).

It can be when the buyer is sound and the gain would otherwise spill into higher brackets, the net investment income tax or IRMAA. An installment sale is any sale where at least one payment arrives after the year of sale; each year you report the principal received times the gross profit percentage, on Form 6252 (IRS Publication 537). For a rental, the recapture portion comes first: the regulations take unrecaptured section 1250 gain into account before the rest of the gain (26 CFR 1.453-12), so the early payments carry the higher-taxed slice.

The costs are real. You become the buyer's lender, and if they default you get the house back in whatever condition they left it. Interest on the note is taxable ordinary income. If you sell to a relative who resells within two years, the IRS treats you as having received the proceeds (IRS Publication 537). And if you die holding the note, it does not get a step-up; your heirs pay tax on the remaining gain as payments come in (26 U.S.C. 691). The installment method suits someone who would otherwise sell outright, not someone who could hold until death.

Plan for the year you cannot. Landlording is physical and legal work: turnovers, repairs, late-night calls, security deposits, fair-housing and eviction rules. A property manager takes a share of the rent plus leasing fees; get two or three written quotes and put them into the cash-flow numbers above, because a fee can turn a modest yield into a thin one. Hiring a manager need not cost you the $25,000 allowance: active participation means making management decisions in a significant and bona fide sense, such as approving new tenants, deciding on rental terms and approving expenditures (IRS Publication 925).

The bigger risk is decline without a plan. A landlord in the early stages of dementia can miss insurance renewals, sign bad leases or fall prey to a contractor scam. Put a durable power of attorney in place that expressly covers real estate, keep a one-page file on the property (lease, insurer, manager, lender, tax records), and decide in advance which child or professional steps in. Our guide to long-term care planning covers how care costs might force a sale at a bad time.

Think of three separate jobs: liability, probate and tax. An LLC addresses liability by keeping a tenant's claim against the property from reaching your other assets, if you respect the formalities; a good umbrella insurance policy is the first line and costs less. For income tax, an LLC with one owner is disregarded and the rental stays on Schedule E. An LLC owned by a married couple is generally a partnership that files its own return, except in community-property states, where the IRS accepts either treatment (Rev. Proc. 2002-69).

A revocable living trust addresses probate. Property in the trust passes without a court process, including the separate probate that property in another state would otherwise need. A revocable trust does not change income tax or the step-up. Moving a deed into an LLC or trust can affect title insurance, lender consent if there is a mortgage, and in some states property tax reassessment or transfer tax, so have the attorney check before recording. Our guide to estate planning basics explains how trusts, wills and beneficiary designations fit together.

Heirs take a basis equal to the property's fair market value at the date of death (IRS Publication 551), and transfers at death are an exception to depreciation recapture (IRS Publication 544). A child who inherits Walt and June's house at $750,000 and sells it soon after owes little or no income tax, and can start depreciation fresh if they keep renting it. With a basic exclusion of $15,000,000 per person in 2026, few households owe federal estate tax, though some states have lower thresholds.

Two traps. Giving the property to children while you are alive passes your low basis to them and gives up the step-up, which on a long-held rental can cost the family six figures; our guide to gifting to children and grandchildren covers what to give instead. And if you give appreciated property to someone who dies within a year and it comes back to you, you keep the old basis. The practical trap is family, not tax: three siblings who inherit one rental must agree on every repair, rent and sale. A will or trust that says whether to sell, lets one child buy out the others at an appraised price, or holds the property in an LLC with a written operating agreement prevents most of those arguments.

If what you want is to stay in your own home and tap its equity rather than a rental's, see how reverse mortgages work; they are available only on a principal residence.

• Quoting the recapture rate as 25%. It is your ordinary rate up to 25%. Model the sale on your actual brackets.
• Skipping depreciation to "avoid recapture." Basis falls by the depreciation allowed whether or not you claim it; you lose the deduction and still owe the tax.
• Forgetting improvements. A roof, windows or a kitchen added to basis reduce the gain. Missing receipts cost real money at sale.
• Moving in to use the exclusion without the math. Nonqualified use since 2009 and all post-1997 depreciation stay taxable.
• Ignoring IRMAA. A sale year raises Medicare premiums two years later, and a property sale is not one of the life-changing events that qualify for Form SSA-44 relief (SSA).
• Touching exchange proceeds. If the money reaches you or your agent, the 1031 exchange fails; use a qualified intermediary from the start.
• Giving the property to children during life. They inherit your low basis instead of a stepped-up one.
• Selling in pieces to family without paperwork. A below-market sale to a child is part gift, part sale, and a resale within two years can accelerate installment gain.

1. Now: assemble the purchase closing statement, depreciation schedules, improvement receipts and any passive loss carryforwards (Form 8582 worksheets). Ask your CPA for your adjusted basis.
2. Now: value the property and compute its yield on today's value with the rental property ROI calculator. Compare it with what the after-tax proceeds would produce in your portfolio.
3. Before listing: have the CPA project the sale year: federal tax, NIIT, state tax and the IRMAA tier two years later. Compare December and January closings.
4. Before listing, if exchanging: engage a qualified intermediary so the exchange agreement is signed before the sale closes.
5. Within 45 days of the sale: identify replacement properties in writing to the intermediary.
6. Within 180 days, or by the return due date if earlier: close on the replacement property. File Form 8824 with that year's return.
7. If selling outright: make an estimated tax payment for the quarter of the sale to avoid underpayment penalties; report the sale on Form 4797 (and Form 6252 for an installment sale).
8. If holding: sign a durable power of attorney that covers real estate, decide who manages the property if you cannot, and have the estate attorney review titling and what your documents say about the property.

For how a sale fits your other income, see our guides to taxes in retirement and Medicare and IRMAA, and the 2026 retirement numbers page for every threshold used here.