Taxes When Selling a Short-Term Rental in 2026. A Complete Guide to Capital Gains, Depreciation Recapture, and How to Minimize What You Owe

Picture this: you bought an STR five years ago for $450,000. You put in the work, you took the depreciation deductions your CPA told you to take, and now you are ready to cash out at $600,000. That is a $150,000 profit. You have owned the property for over a year, so you expect the long-term capital gains rate of 15% to apply. You budget $22,500 for taxes and start thinking about what you will do with the other $127,500.

Then you actually do the math. Or worse, your CPA does it for you in April.

The real federal tax bill on that scenario can easily land between $47,000 and $68,000 before state taxes, depending on your income. The gap between what sellers expect and what they actually owe comes down to a concept most people learn about exactly once: depreciation recapture. If you have been taking depreciation deductions on your STR (and you should have been), the IRS does not let you sell at capital gains rates on the full gain. It carves off the depreciation portion first and taxes it at higher rates.

This article covers the taxes when selling short term rental property in 2026 from every angle: how the calculation actually works, what the Section 121 home sale exclusion does and does not do for STR sellers, how bonus depreciation under the One Big Beautiful Bill changed the recapture picture, and what you can legally do to reduce what you owe.

One note before we get into it: this article is about the straight-sale scenario. If you want to understand the 1031 exchange mechanics, that is covered separately in our guide to 1031 exchanges for STR property. We will compare the two approaches near the end of this article, but the mechanics of a 1031 are not repeated here.

This article provides general information about federal tax law and should not be construed as tax or legal advice. Consult a qualified CPA or tax attorney for advice specific to your situation before making any sale or tax election decisions.

The Three Tax Events When You Sell an STR

When you sell a short-term rental property held for more than one year, the gain does not all get taxed the same way. It gets sorted into up to three separate buckets, each with its own rate. Understanding this is the core of understanding your tax bill.

Tax Event 1: Long-Term Capital Gains on Appreciation

The portion of your gain that represents genuine appreciation above your original purchase price is taxed at long-term capital gains rates: 0%, 15%, or 20%, depending on your total taxable income.

For 2026, the brackets are: the 0% rate applies to single filers with taxable income up to $49,450 and married filers up to $98,900. The 15% rate applies up to $533,400 (single) or $613,700 (married). Above those thresholds, the rate is 20%. These thresholds received a modest inflation adjustment for 2026.

Most STR sellers assume this is the only rate that applies. It is not.

Tax Event 2: Unrecaptured Section 1250 Gain (The 25% That Surprises Sellers)

When you depreciated the building portion of your STR, you reduced your taxable income each year. When you sell, the IRS recaptures that benefit by taxing the depreciation-equivalent portion of your gain at a higher rate.

For real property placed in service after 1986 (which covers every STR currently being sold), all building depreciation uses the straight-line method over 27.5 years. When you sell, the portion of your gain equal to the total straight-line depreciation you took (or were allowed to take, whether you claimed it or not) is called “unrecaptured Section 1250 gain” and is taxed at a maximum rate of 25%.

The word “maximum” in that sentence is doing important work. The 25% cap applies regardless of your ordinary income tax bracket. A seller in the 37% bracket still pays only 25% on the 1250 gain. A seller who would normally pay 15% on capital gains pays 25% on the 1250 portion. In most situations, Section 1250 recapture costs more than the headline capital gains rate you expected.

Here is the other thing that catches sellers off guard: even if you never claimed depreciation on your STR, the IRS computes your gain as if you had. Your adjusted basis is reduced by “depreciation allowed or allowable.” Skipping the deduction does not help you avoid recapture. It just means you paid more taxes during ownership and get nothing in return at sale. Take the depreciation. For a full accounting of what you likely deducted during ownership, see our complete guide to STR tax deductions in 2026.

Tax Event 3: Section 1245 Recapture on Personal Property

This is the most expensive bucket for sellers who used cost segregation or took bonus depreciation on their STRs. When a cost segregation study identifies components of your property as personal property (appliances, flooring, countertops, certain fixtures), those components are depreciated on an accelerated schedule: 5 years, 7 years, or 15 years rather than 27.5. Under the One Big Beautiful Bill, which restored 100% bonus depreciation for property acquired after January 19, 2025, many of those components can be fully deducted in the first year.

When you sell, all of that accelerated depreciation on personal property components is recaptured under Section 1245 as ordinary income, not capital gains. For a seller in the 24% bracket that means 24%. For a seller in the 37% bracket that means 37%. There is no cap equivalent to the 25% ceiling on Section 1250 gain.

The practical result: sellers who aggressively used cost segregation and bonus depreciation reduced their taxes during ownership, which was the right call. But when they sell without a 1031 exchange, they face recapture that hits at ordinary income rates on the personal property portion. The decision to cash out is where that math becomes painful.

A Worked Example: The Real Tax Bill on a $450,000 STR

Let us run the actual numbers using the scenario from the opening: $450,000 purchase price, five years of ownership, $100,000 in accumulated depreciation, and a sale at $600,000. Assume the seller used cost segregation and split the depreciation between building and personal property.

• Total accumulated depreciation: $100,000
• Section 1250 (building depreciation, straight-line over 27.5 years): $70,000
• Section 1245 (personal property via cost segregation and bonus depreciation): $30,000
• Adjusted basis: $450,000 minus $100,000 = $350,000
• Sale price: $600,000
• Total gain: $600,000 minus $350,000 = $250,000

That $250,000 gain now gets sorted into its three buckets:

• Section 1245 recapture (ordinary income): $30,000
• Unrecaptured Section 1250 gain (max 25%): $70,000
• Long-term capital gain on appreciation: $150,000

For a mid-income seller (24% ordinary income rate, 15% LTCG bracket):

• Section 1245: $30,000 x 24% = $7,200
• Section 1250: $70,000 x 25% = $17,500
• LTCG: $150,000 x 15% = $22,500
• Federal total: approximately $47,200

For a high-income seller (37% ordinary rate, 20% LTCG bracket, NIIT applies):

• Section 1245: $30,000 x 37% = $11,100
• Section 1250: $70,000 x 25% = $17,500
• LTCG: $150,000 x 20% = $30,000
• NIIT: $250,000 x 3.8% = $9,500
• Federal total: approximately $68,100

These are federal numbers only. California adds up to 13.3% on gains. New York adds up to 10.9%. Even lower-tax states may impose transfer taxes or documentary stamp taxes on the sale. State taxes are not included in the figures above, and they can push the total bill meaningfully higher depending on where your property sits.

The effective tax rate on the total $250,000 gain ranges from roughly 19% to 27% at the federal level before state taxes. That is well above what most sellers budget when they see “long-term capital gains” and assume 15%.

Before you finalize a listing price or structure an offer, running a current market valuation is essential. The StaySTRA Analyzer gives you current revenue, occupancy, and ADR data on comparable properties in your market. For a deeper look at how to put a number on your STR’s business value, see Meredith Lane’s guide to valuing your STR before you sell.

Does the Section 121 Exclusion Apply to Your STR?

Section 121 is the rule most sellers hope applies to them. It allows single filers to exclude up to $250,000 in capital gains and married couples to exclude up to $500,000 when selling a primary residence. If it fully applied to your STR, it could eliminate the appreciation portion of the gain entirely. The complication is that it rarely applies the way STR sellers hope, and when it does apply, it is usually reduced.

The Basic Test: Two of Five Years as Your Primary Residence

To qualify for Section 121 at all, you must have owned and used the property as your principal residence for at least two of the five years before the sale. If your STR was never your primary residence (the typical case for a vacation rental or investment property purchased specifically as an STR), Section 121 does not apply. Full stop. You cannot use it to shelter any portion of the gain.

The Mixed-Use Scenario: When It Partially Applies

Some sellers converted a former primary residence into a short-term rental. A homeowner who lived in a mountain cabin for three years, then turned it into an STR for the next two years before selling, may technically meet the two-of-five test. But the Housing Assistance Tax Act of 2008 added a “non-qualifying use” provision that complicates this. Any period the property was NOT your primary residence (after January 1, 2009) reduces the exclusion proportionally.

The allocation works like this: the non-qualifying use fraction equals total months of non-primary-residence use divided by total months of ownership. That fraction of your total gain is not eligible for exclusion, even if you otherwise satisfy the two-of-five test.

There is a meaningful exception: any period of non-primary-residence use that occurred AFTER the last date you used the property as your primary residence (within the five-year lookback) does not count against you. This is called the “trailing period exception.” In plain terms: if you lived in it and then rented it as an STR before selling, the STR period at the end does not reduce your exclusion. The non-qualifying use that reduces the exclusion is use that came BEFORE your primary residence period, not after it. Sellers who converted to an STR in the final year or two of ownership before selling are in a much better position under Section 121 than sellers who rented first and then moved in.

Section 121 Does Not Shelter Depreciation Recapture

Even if you qualify for the full exclusion and shelter all of your capital gain, Section 121 does not protect against depreciation recapture. The Section 1250 unrecaptured gain and any Section 1245 recapture are not excludable under Section 121. You still pay recapture tax on all accumulated depreciation regardless of whether the appreciation gain is excluded. This is one of the more consistently misunderstood points in STR tax law, and it tends to surface at the closing table at the worst possible time.

How Bonus Depreciation Changes the Recapture Picture

The One Big Beautiful Bill (H.R. 1, signed July 4, 2025) permanently restored 100% bonus depreciation for qualifying property acquired after January 19, 2025. IRS Notice 2026-11 (January 14, 2026) provides the interim implementation guidance. The critical rule is that the acquisition date (not the placed-in-service date) controls eligibility, and binding contracts signed before January 20, 2025 remain on the old TCJA phase-down schedule. For the full breakdown of those rules, see our OBBBA bonus depreciation guide.

The restoration matters for sellers because it changed how much personal property depreciation STR buyers took starting in 2025. A buyer who purchased a $500,000 STR in 2025 and had a cost segregation study done may have identified $80,000 to $120,000 of 5-year and 7-year personal property and deducted 100% of it in year one. That is excellent tax planning during ownership.

The seller consequences arrive when the property changes hands. Every dollar of bonus depreciation taken on personal property is Section 1245 property. At sale, it all comes back as ordinary income. There is no spread, no phase-in, no favorable rate. If you deducted $90,000 in bonus depreciation on personal property components in year one and then sell three years later, the full $90,000 is taxed at your current ordinary income rate in the year of sale.

Cost segregation deductions were probably still the right choice, because the time value of those early deductions plus reinvestment returns can outpace the eventual recapture cost. But sellers who took aggressive bonus depreciation and are now considering a straight sale need to run the numbers carefully before assuming the sale makes financial sense versus holding or doing a 1031.

NIIT: The 3.8% That Quietly Adds to Your Bill

The Net Investment Income Tax (NIIT) is a 3.8% surtax that applies to investment income for taxpayers whose MAGI exceeds $200,000 (single) or $250,000 (married filing jointly). These thresholds are not indexed for inflation and have not changed since the NIIT was enacted in 2013.

On the high-income example above, NIIT adds $9,500 to the federal tab on a $250,000 gain. Stacked on top of 20% LTCG rates, 25% Section 1250 rates, and 37% Section 1245 rates, the effective blended rate on total gain can push above 27% at the federal level before state taxes. That is a real number that belongs in your proceeds calculation before you set a listing price.

Whether NIIT applies depends on whether your STR activity was passive or non-passive during ownership. If you did not materially participate in the STR, the income and the resulting gain are passive, and NIIT applies. If you did materially participate and your average period of customer use was seven days or less (which most STRs satisfy on the rental side), the activity may fall outside the passive activity rules entirely, and NIIT may not apply to the gain at sale. This is worth clarifying with your CPA before closing, not after.

Strategies to Reduce What You Owe

The depreciation recapture is locked in the moment you sell. You cannot undo it by timing or restructuring. What you can control is the capital gains portion and, in some cases, whether NIIT applies.

Time Your Sale to a Lower-Income Year

Long-term capital gains rates depend on your total taxable income. A year with lower W-2 income, lower investment income, or larger deductions could move you from the 20% bracket into the 15% bracket. On $150,000 of appreciation, that is $7,500. Dropping below the NIIT threshold saves another $9,500. Year-end tax planning around a sale is not exciting, but the numbers are real.

Installment Sale Notes

If you carry seller financing and structure an installment sale, you recognize gain (and pay tax on it) as payments arrive rather than all at once at closing. This can spread the capital gain across two or three tax years, potentially keeping you in a lower rate bracket in each year. There is a key limitation: Section 1245 recapture on personal property components must be recognized entirely in the year of sale, regardless of when payments arrive. However, unrecaptured Section 1250 gain on the building and the remaining capital appreciation portion can be spread across installment payments. For sellers where the Section 1245 exposure is a small share of total gain, installment treatment can still meaningfully defer the larger portions.

Qualified Opportunity Zone Funds

Reinvesting recognized gains (not recapture) into a Qualified Opportunity Zone fund within 180 days of the sale defers the gain until December 31, 2026, or until you exit the QOZ investment. If you hold for 10 or more years, appreciation inside the fund can be permanently excluded from tax. This is a legitimate strategy for sellers with large capital gains, long time horizons, and access to quality QOZ investments. The rules are detailed and the fund quality varies widely. Use it with eyes open.

Know Your Net Before You List

One underused strategy is simply running the tax calculation before pricing the property. Many STR sellers set a price based on gross equity without modeling their actual net proceeds after taxes. Knowing the number in advance tells you whether a given offer makes financial sense, helps you set a rational floor price, and informs the hold-versus-sell analysis. For sellers with significant STR equity who want to access capital without selling, our guide to DSCR loan financing for STRs covers how DSCR lenders underwrite short-term rental income and what you might qualify for as a cash-out refinance alternative.

The 1031 Question: When Exchange Beats Cashing Out

The 1031 exchange is the one mechanism that defers all of the tax: Section 1245 recapture, Section 1250 unrecaptured gain, capital gains, and NIIT. A properly executed exchange defers everything. Nothing is paid at closing, and the full equity rolls into the replacement property.

The financial case is straightforward: if your total deferred federal tax bill on a straight sale would be $55,000 to $68,000, and you redeploy that capital into a replacement property generating an 8% annual return, the compounding benefit of the avoided tax over 10 years is substantial. You have converted a tax bill into investment capital.

The 1031 exchange has real constraints. There are strict 45-day and 180-day deadlines. The replacement property must be like-kind real estate held for investment, of equal or greater value to fully defer the gain, and your STR must qualify under the personal-use and investment-intent standards. Not every STR qualifies automatically. Our full 1031 exchange guide for STR sellers covers the qualification rules, Rev. Proc. 2008-16 safe harbor mechanics, and the qualified intermediary requirements in detail.

When does a straight sale make more sense than an exchange? When you need the liquidity, when your tax bill is modest enough that the exchange overhead is not worth it, when you have capital losses elsewhere that offset the gain, or when you genuinely want to exit real estate as an asset class. For sellers in the lower capital gains brackets with minimal depreciation recapture exposure, a clean sale may be the simpler and more profitable path. The analysis depends on your specific numbers.

Running those numbers starts with knowing what your property is actually worth today. The StaySTRA Analyzer pulls current revenue and occupancy data for your market to give you a data-driven picture of your property’s income potential, which both buyers and appraisers will use to price the asset.

We do our best to keep our tax guides accurate and up to date, but tax law changes and individual circumstances vary significantly. This article is for general informational purposes only and does not constitute tax or legal advice for any specific situation. Always verify with a qualified CPA or tax attorney before making any transaction or tax planning decisions.

Thinking about selling and want to know what your STR is actually worth in today’s market? Run your property through the StaySTRA Analyzer to get current revenue, occupancy, and ADR benchmarks for comparable properties in your area. Knowing your market value is step one before modeling whether the sale price justifies the tax bill.