This article was originally published on April 26, 2024.
Quick Take: Understand how capital gains taxes affect multifamily real estate investing. This guide defines capital gains, clarifies what triggers capital gains tax on investments, and explains short‑ vs. long‑term rates, unrecaptured Section 1250 depreciation, the 3.8% NIIT, and state rules. Learn how to calculate capital gains tax on real estate investment property using adjusted basis, depreciation, and net proceeds. Explore proven ways to defer or reduce taxes, including 1031 exchanges and Qualified Opportunity Funds.
For high-net-worth investors in multifamily real estate, capital gains taxes can materially affect net returns. By using smart tax strategies and staying current on tax law, investors can potentially improve outcomes. I’ll explain how capital gains taxes work on real estate investment property and what triggers capital gains tax on investments, with examples tailored to multifamily deals.
Let’s start by clarifying what constitutes a capital gain. A capital gain is the profit realized when you sell or dispose of a capital asset—such as stocks, bonds or real estate—for more than your cost basis. Put simply, when the selling price exceeds the purchase price (adjusted for costs), the difference is a capital gain. For example, if you buy an investment property for $250,000 and later sell it for $400,000, the $150,000 difference is a capital gain. And tax may be due when the gain is realized at sale. I’ll cover real estate-specific rules like the holding period, adjustments to basis and potential deferral strategies below.
Short- vs. Long-Term Capital Gains Taxes on Real Estate Investment Property
The sale of an investment triggers tax. But how long you have held the investment determines whether any gain on the sale is taxed as short-term or long-term. States tax capital gains differently (use this tool to find each state’s capital gains tax rate). At the federal level, taxation of gains is contingent upon factors including the duration of ownership and the investor’s income bracket.
Below, I offer simple explanations of how capital gains are taxed.
Short-term capital gains (asset held less than one year):
- Assets held one year or less
- Taxed at ordinary income rates (10% to 37% at the federal level)
- Example: Let’s say you buy a multifamily property on Jan. 1 for $1,000,000 and sell it on Sept. 1 for $1,100,000. After $20,000 in closing and improvement costs, the short‑term capital gain is about $80,000, taxed at ordinary rates. State taxes may apply.
Long-term capital gains (asset held more than one year):
- Taxed at long‑term rates (0%, 15% or 20% based on income)
- Long-term capital gains (held more than 1 year)
- Unrecaptured Section 1250 gain: When you sell a real estate investment, the part of your profit tied to depreciation you previously claimed is subject to capital gains taxes at up to a 25% rate.
- Example: Let’s say you buy a property in 2020 for $1,000,000. You take $100,000 depreciation and sell it in 2025 for $1,300,000. Your adjusted basis is about $900,000; your total gain is about $400,000. Up to $100,000 may be taxed at 25%, with the remainder taxed at long-term rates. State taxes may apply.
Net investment income tax (NIIT):
- High‑income investors may owe the 3.8% net investment income tax, or NIIT, which stacks on top of the federal rates explained above. Calculate the NIIT by adding up all income you earned from investments in the applicable tax year, minus any expenses.
Income Thresholds for NIIT Surtax
Strategies to Defer or Reduce Capital Gains Taxes on Real Estate Investment Property
Capital gains taxes can materially impact after‑tax returns. But investors can employ a couple of strategies to manage the tax on real estate investment property: Qualified Opportunity Funds and 1031 exchanges.
Qualified Opportunity Zones (QOZs)
- What they do: Investors can defer tax on eligible capital gains by investing in a Qualified Opportunity Fund
- Key rules: Investors have 180 days from the realization date of the capital gain to invest the gain in a QOZ fund. Any gain is deferred through 2026. Holding the investment for more than 10 years can potentially exclude tax on its post‑investment appreciation. (Learn more about Origin’s QOZ Fund III here. And find out how 2025 updates to QOZ law will impact future investments in this tax-efficient option.)
1031 Exchanges
What they do: Under Section 1031 of the Internal Revenue Code, investors can defer capital gains tax by selling investment real estate and reinvesting the proceeds, via a qualified intermediary, into like‑kind real property. This strategy allows investors to defer taxes indefinitely as long as they continue to reinvest in qualifying properties.
Key rules: Investors must identify replacement property within 45 days and close within 180 days. And they must follow strict rules on property value and debt to avoid penalties. (See our guide on how 1031 exchanges work and how they compare with QOZs. And learn more about the Origin Exchange platform).
Capital gains taxes can have a big impact on an investor’s income and returns. Understanding how they work—and knowing when they are realized—is a critical part of an overall investment strategy. By structuring your investments to account for capital gains taxes, you can keep more investment profits for yourself.
Key Takeaways
- Capital gains taxes are triggered when you sell or otherwise dispose of an asset. How long you held the asset determines short-term (less than one year) vs. long-term (more than one year) tax treatment.
- Short-term gains are taxed at ordinary income rates. Long-term gains are taxed at preferential rates. And real estate may include unrecaptured Section 1250 gain taxed up to 25%.
- High-income investors may also owe the 3.8% net investment income tax (NIIT), and most states tax capital gains. Rates and rules vary by state.
FAQs
What triggers capital gains tax on investments?
Typically, a taxable sale or disposition (like selling real estate or securities, certain partnership redemptions, or an exchange that doesn’t meet deferral rules) triggers capital gains taxes.
How do I calculate capital gains tax on real estate investment property?
Start with net sale proceeds, subtract adjusted basis (purchase price + capitalized costs + improvements − depreciation). The result is your gain. In real estate, part of the proceeds may be considered unrecaptured Section 1250 (taxed up to 25%), with the remainder at short-term or long-term rates. NIIT and state taxes may apply.
What are the current federal rates for short- and long-term capital gains?
Short-term gains are taxed at the investor’s ordinary income bracket. Long-term gains are generally 0%, 15%, or 20% based on income. Real estate may include up to 25% on unrecaptured Section 1250 depreciation. High earners may also owe the 3.8% NIIT.
Does a 1031 exchange eliminate capital gains taxes?
No. 1031 exchanges defer tax if you reinvest sale proceeds into like-kind real property via a qualified intermediary, identify within 45 days, and close within 180 days.
How do Qualified Opportunity Zones (QOZs) reduce capital gains taxes?
Invest eligible capital gains into a Qualified Opportunity Fund within 180 days to potentially defer the original gain. If you hold the QOF investment for at least 10 years, you can generally exclude tax on the QOF’s post-investment appreciation.
