Real estate capital gains guide

Selling a home or rental property creates a unique blend of capital gains rules, exclusions, and recapture calculations. Careful record keeping can mean the difference between a six-figure exclusion and a surprise tax bill.

Step 1: Confirm ownership and use

To claim the primary residence exclusion you must satisfy the 2-out-of-5 test. Track the months you owned the property and the months you actually lived in it. Short absences (vacations, work travel) count as use. Longer rentals reduce the available exclusion.

Step 2: Build your adjusted basis

• Start with the original purchase price plus buyer-side closing costs.
• Add the cost of capital improvements: additions, new roofing, HVAC upgrades, landscaping projects that add value.
• Subtract any depreciation claimed while the property was rented or used for business purposes.

IRS references: Publication 523 and Publication 527.

Step 3: Estimate depreciation recapture

Depreciation reduces your basis and triggers “recapture” when you sell. The recaptured portion is taxed at a maximum 25% federal rate and cannot be sheltered by the primary residence exclusion. Include improvement schedules from your tax returns to prove the numbers.

Step 4: Evaluate partial exclusions

If you fail the 2-out-of-5 test because of a work relocation, health reasons, or other IRS-approved hardships, you may still claim a prorated exclusion. Multiply the full exclusion by the fraction of two years you satisfied the test. Publication 523 outlines qualifying scenarios.

State-level considerations

• California: No special capital gains rate—your full gain is taxed as ordinary income. Be mindful of the 1% mental health surtax on taxable income above $1 million.
• New York: High-income taxpayers in NYC face combined state + city rates exceeding 12%.
• Massachusetts: A 4% surtax applies to combined income above $1 million.
• Washington: The 7% excise tax applies to long-term capital gains over $250,000 but exempts primary residences up to $750,000 of gain.

Next steps

Use the real estate capital gains calculator to model your sale with actual improvement receipts and rental history. Then export the breakdown for your CPA or financial planner. If you are considering multiple sale windows, plug the numbers into the scenario planner to compare total tax across states or calendar years.