Capital Gains Tax

Capital gains tax is the tax on profit from selling an asset. In the US, gains on property held longer than a year are taxed at long-term capital gains rates, which are lower than ordinary income rates. It affects your total return on a rental but not the pre-tax cash on cash return.

At sale, the gain attributable to depreciation already taken is generally taxed separately under depreciation recapture rules. The rest is taxed at the long-term rate that applies to the seller's income, plus any state tax.

Tax rules like the 1031 exchange can defer the tax when proceeds go into another investment property. Deferral keeps more equity working, which can raise the cash on cash return on the next purchase. Tax outcomes depend on individual circumstances, so confirm them with a tax professional.

Further reading: Capital Gains Tax on Wikipedia.