Advice for home owners February 7, 2023

SPECIAL REPORT: California CAPITAL GAINS TAX Rules real estate investors and homeowners should know before selling

By Scot Campbell, Broker | Coldwell Banker-Campbell Realtors | | 714-336-0394

In March 2022, writer Jeff White wrote an interesting article which was published in Seeking Alpha.  I read the article recently and made some notes… below are the interesting points and examples I organized for your consideration while I was reviewing the article.

Capital Gains Tax Rates in California

Unlike some other states, all California capital gains are taxed as ordinary income. Capital gains or losses occur when an asset is sold for either more or less than you spent to purchase that asset. Capital gains are taxed when you sell the item for more than you bought it for, which creates a realized gain.

The capital gains tax rates in California for 2022, unlike federal capital gains taxes, do not depend on whether it’s a short-term or long-term gain.

This California capital gains tax rate is applied to the profit you make from selling certain assets, like stocks or real estate. The capital gains tax rate is the same as the applicable ordinary income tax bracket (1%-13.3%) being charged on income for the year.

How the California Capital Gains Tax Works

To calculate your capital gains taxes in California, you’ll need to know your marginal tax bracket.

The California capital gains tax is imposed on the sale or exchange of capital assets located in California. The tax is calculated using the following formula:

Capital Gain = Sale Price of Asset – (Adjusted Basis + Selling Expenses)

In addition to the Federal Capital gains taxes due, the California capital gains tax rate that you pay on your capital gain depends on your taxable income which in turn determines the tax bracket. Your tax expert will use your normal (ordinary income) tax bracket rate to calculate how much of the gain you’ll be taxed on (between 1% – 13.3%).

For example, let’s say you bought a Rental House in Orange County for $500,000 and sold it later for $740,000.

  • Your capital gain would be $240,000 ($740,000 – $500,000) before adjusting the basis.
  • If your adjusted basis was $550,000 (e.g., purchase price + capital improvements), your capital gain would be reduced $50,000 to $190,000.
  • Finally, if you had selling expenses of $40,000 (e.g., real estate commissions, recording, title, & escrow fees), your capital gain would be further reduced to $150,000.

In this example, the California capital gain tax payable would be $150,000 X your marginal tax bracket as computed by your tax expert while filing your state tax return.

Federal capital gains taxes are calculated separately for the federal tax return.

California Capital Gains Tax on Principle Primary Residences

For homeowners who qualify for the IRS Section 121 exemption, the California capital gains taxes may be reduced to zero.  To qualify, the home must be the homeowner’s principle primary residence for two out of the last five years.

The tax is calculated by taking the selling price of the property, then subtracting: the original acquisition cost, capital improvements that were made to it during ownership, and finally the closing costs during the escrow.

According to IRS Section 121 single homeowners can deduct up to $250,000 of gains from the sale of their primary residence as long as they meet the requirements. Couples can exclude a gain of up to $500,000.

So, for those selling a qualifying principle primary residence, it is possible to be excluded from paying both Federal and California capital gains taxes altogether provided the gain is $250,000 (or less) for single tax filers or $500,000 (or less) per spouse for joint tax filers.

Questions?  Feel free to reach out to me.  There may be additional considerations worth exploring when it comes to your real estate portfolio.  I am happy to consult you.

One last thing:  Seek Tax Advice Before Transacting

The information contained herein is intended to provide general information and is not intended as a substitute for individual legal advice. Specific examples used are only general examples, and the actual amount of capital gains and property taxes owed for any person will depend on the specific situation of the individual and a wide variety of other factors. Therefore, all persons are directed to seek the advice of an attorney regarding their specific tax and legal situation.