Do you owe Washington’s capital gains tax when you sell a rental property?

Washington passed its capital gains excise tax in 2021, and the state Supreme Court upheld it in 2023. It taxes long-term gains on things like stocks, bonds and interests in businesses once a person’s gains for the year pass a standard deduction, and in 2025 the Legislature added a higher rate on very large gains. That second change put the tax back in the news, which is part of why so many rental owners assume it will land on their sale.

It does not. Real estate sits on the Department of Revenue’s list of exempt assets, and the department’s guidance says so directly, with no exception for holding period, past occupancy or the type of owner. A duplex in South Tacoma, a brick fourplex in Spokane and a rental house in Kennewick all fall under the same rule.

Most people use “capital gains” to mean any profit on anything, which explains the mix-up. If you also sold a large block of stock in the same year, that part of your year may still matter to the state, so hand your CPA the whole year’s activity.

Plenty of small investors hold rentals in an LLC, and the exemption still works when the LLC is the seller. The entity sells the property, a deed is recorded, and the gain comes from real estate.

The detail to watch is a sale of the entity itself. If you and a partner sell your membership interests and the LLC keeps title to the building, the Department of Revenue exempts that sale only to the extent the gain is directly attributable to real estate the entity owns directly. An LLC that also holds a large cash balance, a promissory note from an earlier sale, or an interest in another company can end up with a portion of the gain that the exemption does not cover. The word “directly” matters when one entity owns another, too.

Entity sales carry a second Washington wrinkle. A transfer of a controlling interest in an entity that owns Washington real estate can trigger the real estate excise tax even though no deed changes hands. If you are thinking about restructuring ownership before a sale, talk to a real estate attorney and a CPA first, together if you can.

A revocable living trust is usually the simple case: the trustee signs the deed, and it is a sale of real estate.

Federal tax is where the real money usually sits. The gain on a rental held for more than a year is generally a long-term capital gain for federal purposes, and a shorter hold is taxed as ordinary income.

The part that surprises first-time sellers is depreciation recapture. Each year you own a rental, depreciation lowers your taxable rental income. When you sell, the IRS taxes the portion of your gain that came from that depreciation at its own rate, separate from the rest of the gain. The rule applies to depreciation that was “allowed or allowable,” which means you can owe recapture on depreciation you were entitled to take even if you never claimed it.

The Washington tax you will actually pay on a rental sale is the real estate excise tax, usually shortened to REET. It is charged on the full sale price, so you owe it even on a sale at a loss. The state portion uses graduated brackets that the Department of Revenue publishes and adjusts from time to time. Cities and counties add a local portion, and the local rate differs from one jurisdiction to the next.

State law places REET on the seller. In practice you never write a separate check: escrow calculates it, collects it from your proceeds, and submits it with the excise tax affidavit filed with the county treasurer. When you ask an agent or escrow officer for a net sheet before listing, REET should be one of the largest lines on it after the loan payoff and commissions.

A like-kind exchange under Section 1031 of the Internal Revenue Code lets an investor sell one investment property and buy another while deferring federal tax on the gain. The rules are strict. A qualified intermediary has to be in place before the sale closes and holds the money in between. You have 45 days from the sale to identify replacement property in writing and 180 days to close on it, or less if your tax return comes due first. If the proceeds touch your bank account, the exchange fails.

For a Washington owner, the exchange is purely a federal tool, because the state capital gains tax was never going to apply to the real estate. REET is still due on the property you sell. And an exchange only postpones the tax, so the recapture and the gain carry forward into the replacement property.

The real risk with an exchange is the clock. Forty-five days is not long to find a property that pencils out, and investors under deadline pressure sometimes buy something they would have passed on with more time. Line up candidates before you list, and run each one the same way you ran the first purchase.

When I underwrite a rental on the rental analysis side of this site, the sale at the end gets its own line of thinking. Selling costs, REET, recapture and federal tax all come out of the same equity you are counting on. A quick screen like the one in the 1% rule, tested against Washington rentals says nothing about the exit, which is one more reason to treat it as a first filter only.

The other half of planning the exit is paperwork. The tax on your sale depends on your basis, your basis depends on records you keep from the day you buy, and a future buyer will ask for some of the same file:

• The settlement statement from your purchase.
• Receipts for capital improvements, such as a new roof, a replaced side sewer or new windows.
• The depreciation schedules from each year’s tax return.
• City license and inspection records. What each city requires is laid out in the guide to Washington rental licenses by city.

Everything here is general. Your own sale belongs in front of a CPA, and in front of a real estate attorney as well if an entity or a trust holds title. None of it is tax or legal advice.