Short answer: It depends on character. Direct long-term capital gain from a real-property sale is generally excluded from Washington taxable income under ESSB 6346 §302 and RCW 82.87.050. Ordinary components — short-term gain, dealer or inventory income, §1245 ordinary recapture, actual ordinary §1250, §1231(c) lookback ordinary, and §751 hot-asset amounts — are not excluded merely because real estate is involved. Gains from entity interests or stock follow different rules. “Real-estate gain” is not one tax category.
This is one of the most common questions I've been getting since Governor Ferguson signed ESSB 6346 into law on March 30, 2026. Anyone selling a $3 million house wants to know what they owe under the state's new 9.9% income tax. Here's the character-first map.
This post is part of our Complete Guide to Washington's New Income Tax.
Character Matters: Quick Map
| Gain component | Generally in WA 9.9% base? |
|---|---|
| Direct real-property LTCG | Generally excluded |
| Net §1231 gain treated as LTCG | Generally excluded |
| Unrecaptured §1250 (special federal rate) | Generally excluded as LTCG |
| §1245 ordinary (depreciable personal property) | Can remain |
| Actual ordinary §1250 | Can remain |
| §1231(c) lookback ordinary | Can remain |
| LLC/partnership interest sale | Depends (RE slice vs §751 / other) |
| RE-corporation stock | Not a direct RE sale |
| REIT (shares / non-timber CG distributions) | Depends on character / CGT |
“Excluded” above means the qualifying long-term capital-gain component is stripped under §302(1) and is not brought back under §302(3) when the sale is exempt under RCW 82.87.050. Other income can still put you over the $1 million standard deduction.
How Section 302 Works
Washington's personal income tax (ESSB 6346), scheduled to begin in 2028, imposes a 9.9% tax on Washington taxable income. Start with federal adjusted gross income (IRC §62). Modifications under §§302–308 and 401–407 produce Washington base income; further adjustments under §§309–314 (including the initial $1 million standard deduction — spouses or registered domestic partners share one) produce Washington taxable income.
The real-estate coordination runs through Section 302 and Washington's existing capital gains tax (chapter 82.87 RCW):
- §302(1) subtracts any long-term capital gains included in federal AGI.
- §302(2) adds back long-term capital losses included in federal AGI.
- §302(3) applies only if you are owing tax under chapter 82.87 for that year. It adds Washington capital gains subject to that tax, plus the amount deducted under RCW 82.87.060(1) — and it must not include long-term capital gains or losses from sales exempt under RCW 82.87.050.
Direct real-property LTCG exempt under RCW 82.87.050(1) is stripped by §302(1) and barred from the §302(3) addback. It does not enter Washington base income.
Owing no capital gains tax does not mean every real-estate-connected dollar is outside chapter 82A. Character still controls. Absence of chapter 82.87 liability turns §302(3) off; it does not itself re-enter real-property LTCG into the income-tax base — those dollars already left under §302(1) — and it does nothing for ordinary or short-term amounts that §302 never subtracts.
RCW 82.87.050(1) covers “all real estate transferred by deed, real estate contract, judgment, or other lawful instruments that transfer title to real property and are filed as a public record.” Qualifying long-term gain on a primary residence, investment property, or commercial realty sold that way generally follows the exclusion path above. Amounts already outside federal AGI (for example, home-sale gain excluded under IRC §121) never start in the Washington calculation.
§1231 Gain — and the Lookback Exception
For chapter 82.87 purposes, “capital asset” includes property whose sale produces gain treated as long-term capital gain under IRC §1231. ESSB 6346 §101(6) imports those long-term capital gain meanings into the income tax. So net §1231 gain treated as LTCG is within the §302(1) subtraction. If that gain is from a direct real-property sale exempt under RCW 82.87.050(1), it stays out of the §302(3) addback as well.
Do not assume every §1231 dollar is excluded. Under IRC §1231(c), lookback can recharacterize what would otherwise be long-term capital gain as ordinary income. Ordinary §1231(c) amounts are never subtracted by §302 and can remain in the Washington income-tax base (subject to the $1 million deduction and other adjustments).
Unrecaptured §1250 Is Not Ordinary Income
Unrecaptured section 1250 gain is still long-term capital gain for federal purposes — it just faces a maximum 25% federal rate. A higher federal rate does not make it ordinary income. For a direct real-property sale, that LTCG component is generally stripped by §302(1) and kept out of §302(3) under the RCW 82.87.050 path.
Separate that from actual ordinary §1250(a) recapture (limited situations after 1986) and from §1245 ordinary recapture on depreciable personal property sold with a real-estate business. Those ordinary pieces stay in AGI, are not subtracted by §302, and can face the 9.9% tax if they help push Washington taxable income above zero after the $1 million deduction.
Entity Asset Sale vs. Owner Interest Sale
Do not collapse these transactions.
The entity sells the real estate. Character is determined at the entity level and flows through to partners or S corporation shareholders. Long-term capital gain (including net §1231-as-LTCG and unrecaptured §1250 treated as LTCG) follows §302 by character. Ordinary pieces remain. For pass-through entity tax elections and credits, see the separate pass-through guide — this FAQ does not restate those mechanics.
You sell your LLC or partnership interest. Under RCW 82.87.050(2), gain on an interest in a privately held entity is exempt from the capital gains tax only to the extent it is directly attributable to real estate owned directly by that entity (fair market value minus basis, times the ownership percentage sold, capped at the individual’s long-term capital gain from the interest). Multi-tier structures do not get an unlimited look-through. That exempt long-term slice is stripped under §302(1) and barred from §302(3) addback.
§751 note: Amounts treated as ordinary under IRC §751 (including hot-asset amounts attributable to real property and carved out of the .050(2) exemption math) are ordinary income. They are never subtracted by §302 and can remain in the Washington income-tax base. Remaining non-RE long-term capital gain on the interest may be subject to chapter 82.87 and, if capital gains tax is owed, may return through §302(3).
Stock and REITs Are Not Direct Real Estate
Selling stock of a real-estate corporation is a sale of an intangible, not a deeded real-property transfer under RCW 82.87.050(1). Stock in a privately held C corporation can qualify for the limited real-estate exemption under RCW 82.87.050(2). Calculate the portion attributable to real estate the corporation owns directly, subject to the statutory limits. Publicly traded shares do not qualify for this exemption. Long-term capital gain is stripped by §302(1) and may be added back if you owe capital gains tax that year.
REIT shares and non-timber capital-gain distributions are likewise not “direct real property.” RCW 82.87.050 mentions REITs mainly in subsection (7) for timber-derived amounts. Do not treat a non-timber REIT distribution as an exempt deeded sale. Income-tax treatment still runs through §302’s subtraction and conditional addback, plus the §205 credit when capital gains tax is owed.
Residency and Sourcing
Full-year residents allocate all income to Washington under §401(1), but §302 still strips long-term capital gain worldwide — including long-term gain on out-of-state real property. Part-year residents apply §406 proration and the §315 deduction fraction.
Nonresidents are taxed only on Washington-source amounts. Short-term gains, rents, and other amounts from real property in this state can source under §401(2)(e). Qualifying long-term capital gain on Washington realty is still subtracted globally by §302(1); ordinary and short-term components connected to Washington realty can remain and source here. Out-of-state realty is generally not Washington-source for a nonresident. Interests and stock are intangibles — nonresident sourcing under §401(2)(f) is limited and is not the same as sourcing a deeded real-property sale.
What You Still Owe
Exclusion from Washington’s income tax does not make a transaction tax-free:
- Federal tax — long-term capital gain rates, the special unrecaptured §1250 rate (still LTCG), ordinary recapture rates, and the 3.8% net investment income tax as applicable.
- Washington’s capital gains tax — also exempts direct real-property sales under RCW 82.87.050; other gains may still be in.
- REET — Washington real estate excise tax is a separate transfer tax on the conveyance, not a tax on net gain, and is independent of chapters 82.87 and 82A.
The $1 million standard deduction is a deduction from Washington base income under §314. It is not the same as saying a dollar was “in the base,” and it is not a reason a qualifying real-property LTCG re-enters the calculation.
Examples
Example 1: Simple Home Sale
Assume you sell your Seattle home for $4 million with $2 million of gain, all qualifying as long-term capital gain. Any amount already excluded from federal AGI under IRC §121 stays outside the starting tax base; the remaining qualifying long-term gain is subtracted under §302 and is not added back as a direct real-property gain. REET and federal tax require separate analysis.
Example 2: W-2 Income Plus Home Sale
Assume full-year Washington residency, $800,000 in W-2 income, and $1.5 million of home-sale gain that is entirely qualifying long-term capital gain, with no other income or adjustments. The gain is excluded and the wages are below the initial $1 million standard deduction, leaving no Washington personal income tax. REET and federal tax are separate.
Example 3: Entity Interest Sale with Real Property
Assume a qualifying long-term sale of your 50% interest in a privately held LLC that directly owns a commercial building. The building has a $6 million fair market value and $2 million basis. The statutory real-estate-attributable amount under RCW 82.87.050(2) is $2 million (50% × $4 million), subject to the transaction’s actual gain and statutory caps. Analyze remaining gain and any IRC §751 ordinary amounts separately; character, other exemptions, deductions, and the interaction between the two Washington taxes determine the result.
Example 4: W-2 Income Plus REIT Distributions
Assume $900,000 in wages and $300,000 in long-term capital-gain distributions from a non-timber REIT. First subtract the long-term gain under §302. Whether an addback is required depends on whether Washington capital gains tax is owed for that year. If the full $300,000 is added back and no other adjustments apply, Washington base income is $1.2 million; after the initial $1 million standard deduction, taxable income is $200,000 and income tax is $19,800 before the §205 credit. If no capital gains tax is owed and no addback applies, the wages alone are below the initial income-tax deduction.
The Bottom Line
Start with character. Qualifying long-term capital gain from a direct real-property sale is generally outside Washington’s 9.9% income tax via §302 and RCW 82.87.050. Ordinary pieces, interest sales with §751, and stock or REIT economics are different questions. Get the classification right before the closing — not after.
For the §302 pipeline in full, see Washington Capital Gains Tax vs. the New 9.9% Income Tax. For a complete overview of ESSB 6346, see Washington's New Income Tax: What Founders, Investors, Athletes, and High Earners Need to Know and the Complete Guide to Washington's New Income Tax.
Have questions about how Washington's new income tax applies to your situation? Book a call to discuss your specific facts.
For more on Washington's tax landscape, see the Complete Guide to Washington State Taxes for Startups.
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