Capital Gains on Rental Property

Your taxable gain equals your sale price minus selling costs, minus your adjusted basis. Adjusted basis starts with your original purchase price, adds capital improvements, and subtracts accumulated depreciation you have claimed or were entitled to claim. The portion of gain attributable to depreciation is taxed separately as unrecaptured Section 1250 gain at a maximum federal rate of 25 percent, while the remaining gain is taxed at long-term capital gains rates of 0, 15, or 20 percent depending on your total taxable income.

No. Washington has no state personal income tax, and the state's separate capital gains excise tax, which applies to certain high-value sales of stocks and other assets, expressly exempts real estate. Selling a rental property in Seattle or anywhere in Washington does not trigger a state-level capital gains tax. Only federal capital gains tax, depreciation recapture, and the net investment income tax apply, so any deferral benefit from a 1031 exchange here is a federal benefit rather than a state one.

The net investment income tax is an additional 3.8 percent federal tax on investment income, including rental gain, for taxpayers whose modified adjusted gross income exceeds 200,000 dollars for single filers or 250,000 dollars for married couples filing jointly. It applies on top of regular capital gains tax and depreciation recapture, so a high-income seller can face a combined federal rate well above 20 percent on the gain from a rental sale.

A 1031 exchange defers recognition of gain rather than eliminating it. The deferred gain carries forward into the replacement property's basis. If you eventually sell that property outside of another exchange, the deferred gain becomes taxable at that time. Some owners hold replacement property until death, at which point heirs typically receive a stepped-up basis that can eliminate the deferred gain, but that outcome depends on individual estate circumstances and current law.

Yes. If you take some cash out of the exchange, known as boot, or acquire replacement property of lesser value or with less debt than the property you sold, you will owe tax on the portion of gain equal to that boot, while the remaining gain stays deferred. This flexibility lets you access some liquidity while still deferring the majority of the tax on a Seattle-area rental sale.