Planning to sell your home in California? Then you’ll need to know about California capital gains tax, which, depending on a variety of factors that we’ll outline below, may have a significant impact on how much you earn from the sale of your property.
With that said, the majority of people who sell their homes in California don’t end up paying any tax whatsoever. If you qualify for exemption (as many people do), then you’ll only pay California state capital gains tax on any gains over $250,000 if you’re single or $500,000 if you’re married.
In this article, we’ll cover everything you need to know about capital gains in California, including how it works, who has to pay, and how to legally reduce California capital gains tax on real estate.
Understanding Capital Gains Tax in California
To understand capital gains tax on real estate in California, you first need to understand how capital gains tax works.
Capital gains refer to the profits you make when you sell an asset, such as a house. If you bought your property for $300,000 and then sold it for $500,000, you’ll have a ‘capital gain’ of $200,000.
Capital gains are taxable at both the federal and state levels. In California, the state taxes capital gains in the same way that it taxes normal income (say, your salary). You’ll include the capital gains from the sale of your property (if there are any) when you file your taxes. The Franchise Tax Board explains how capital gains and losses are reported.
Profit from the sale of your property is taxable, but there are many exemptions, and most people don’t end up paying any capital gains on home sale in California.
Who Pays Capital Gains Tax on Home Sales?
There are some property-related taxes that are up for negotiation when selling/buying a property. For instance, a seller may ask the buyer to pay the property transfer taxes.
Capital gains tax does not fall into this category. That must be paid (if applicable) by the seller when they file their taxes.
While the seller is responsible for capital gains tax on home sale in California, not everyone who sells their home will pay capital gains tax. In fact, most sellers don’t do so due to California’s exemptions for house sellers, which we’ll cover in more detail further down the page.
How to Calculate Your Capital Gains Tax
You can use a capital gains tax calculator in California to figure out how much tax you will owe. It’s best to do this before you sell your property so that you have a clear understanding of how much of the money from the sale you’ll actually keep.
You can figure out how much you’ll owe in capital gains tax by first figuring out your capital gains, which is the sale price minus cost basis and selling expenses.
- Sale Price: How much you sell your home for.
- Cost Basis: How much you originally bought the property for, plus capital improvements.
- Selling Expenses: How much you spend on real estate fees, Escrow fees, and transfer taxes.
For example, let’s say that you sell your home for $400,000. You bought it for $250,000, spent $50,000 on improvements, and have selling expenses of $10,000. That would be:
Capital Gain = $400,000 – ($250,000 + $50,000 + $10,000) = $90,000.
Once you know your capital gains, you can figure out whether you’ll owe capital gains tax. In California, those who qualify for primary residence exclusion may be exempt from paying capital gains tax on capital gains up to $250,000 (single) or $500,000 (married). If your capital gains are above that, you’ll pay capital gains tax on any money above that limit.
Ways to Reduce Capital Gains Tax Legally
The best way to legally reduce capital gain tax in California is to ensure that you meet the criteria for primary residence exclusion. This allows home sellers to exclude the first $250,000 (single) or $500,000 (married) of gain from the sale of their property.
To qualify, sellers must meet the following criteria:
- Have owned the home for at least two of the last five years.
- Have used the home as their primary residence for at least two of the last five years.
- Haven’t used this exclusion on the sale of another property within the last two years.
Qualifying for the primary residence exclusion is the most effective way to avoid paying capital gains tax. It’s the main reason most people don’t pay taxes when they sell a property.
You can also reduce capital gains by increasing your cost basis. Be sure to include all capital improvements, such as a new roof, HVAC system, cabinets, countertops, and so forth.
Impact of Duration of Ownership on Tax
California differs slightly from the federal rules on duration of ownership in that it doesn’t make a distinction of how long you’ve owned the property. Capital gains are taxable on all property sales, whether you’ve owned it for ten years or 6 months.
Duration of ownership does, however, impact eligibility for primary residence exemption. You can qualify for the $250,000/$500,000 exclusion by owning and living in the property for two of the last five years.
Exemptions for Home Sellers in California
The most common capital gains tax exemption is the primary residence exclusion.
If you’ve owned and lived in the property for two of the last five years, you can exclude $250,000 (single) or $500,000 (married; file together) of capital gains from the sale of your home.
Partial exclusions can also apply. For instance, if you have a job-related move or have to move for health reasons, you may qualify for primary residence exclusion even if you don’t meet all the criteria.
Reporting Capital Gains Tax from Home Sales
You’ll need to include the home sale on your tax return even if you’re sure that you owe no taxes. The IRS will know about the home sale through the 1099-S Form you complete, and failing to mention it can trigger an investigation. You’ll also need to calculate your cost basis correctly and have any supporting documentation handy in case of an audit. The IRS provides guidance on reporting home sales, including exclusions and documentation requirement
Want to sell your home hassle-free in California? Get an offer from John Medina Buys Houses today.
