Capital Gains Tax on Rental Property

The capital gain is the sale price minus the adjusted basis, taxed at long-term capital gains rates if the property was held over a year. Depreciation recapture is a separate calculation covering the depreciation deductions claimed over the ownership period, and it is taxed at a flat 25 percent rate under Section 1250, regardless of the owner's regular income bracket. A rental that has been depreciated for ten or fifteen years can generate a recapture bill that rivals or exceeds the capital gains portion, which surprises owners who budgeted only for the gain.

Arizona then layers its own ordinary income tax on top of both pieces, since the state does not distinguish between capital gain and recapture income the way federal rules do.

Appreciation across Scottsdale's rental stock, particularly single-family and small multifamily properties bought before the mid-2010s, has outpaced what many owners expect when they finally list. A property purchased for a few hundred thousand dollars and rented out for a decade can easily be worth two to three times that today, and every dollar of that increase becomes part of the taxable gain calculation at sale, on top of whatever depreciation has already been claimed.

A properly structured 1031 exchange defers both the capital gain and the depreciation recapture, not just one or the other, as long as the replacement property is like-kind investment or business real estate and the exchange rules are followed to the letter. The gain does not vanish; it carries forward into the new property's basis, and depreciation recapture on the original property gets deferred rather than triggered at the sale. This is why exchanges are common among Scottsdale landlords who want to move into a different property type, such as trading a management-heavy single-family rental for a fractional interest in a Delaware Statutory Trust, without paying tax on the transition.

Full deferral depends on reinvesting all of the net proceeds and matching or exceeding the debt paid off on the relinquished property; falling short of either creates boot, which is taxable in the year of the exchange even though the rest of the transaction is deferred.

Selling without an exchange means the capital gain and the recapture are both recognized in the year of sale, reported on the owner's return, and taxed at their respective rates. Some owners choose this path deliberately, particularly when they are exiting real estate ownership entirely and do not want to be tied to another property's 45-day and 180-day deadlines. Others discover only after closing that an exchange would have saved a meaningful amount, which is why the decision needs to be made before the sale contract is signed, not after.

Owners weighing the two paths sometimes split the difference by exchanging into a smaller or more passive replacement, rather than either cashing out entirely or trading into another management-heavy rental. A single-family Scottsdale rental exchanged into a fractional DST interest, for example, keeps the deferral intact while removing the landlord duties that made the owner want to sell in the first place, which is a common enough pattern that it's worth raising with a CPA even when the initial instinct is simply to sell and be finished with tenants.