How Much Capital Gains Tax on a California House Sale?

Understanding the tax implications of selling a home, especially in California, is important for homeowners. When a property is sold for more than its initial cost plus improvements, the profit is considered a capital gain. This gain can be subject to taxation at both federal and state levels, potentially impacting the net proceeds from the sale. Navigating these rules requires understanding how gains are calculated and which exclusions or deductions may apply.

Calculating Your Capital Gain

Determining the capital gain from a home sale begins with establishing the adjusted basis of the property. This basis includes the original purchase price, along with certain allowable closing costs incurred during the acquisition, such as title insurance, recording fees, and non-deductible loan points. The adjusted basis is further increased by the cost of qualified capital improvements made to the home. These improvements add value, prolong the property’s life, or adapt the property to new uses, including significant renovations like adding a room, replacing the roof, upgrading the heating system, or remodeling a kitchen or bathroom. Routine repairs and maintenance, such as painting a room or fixing a leaky faucet, do not increase the basis.

Next, account for selling expenses. These are costs directly related to the sale of the home and serve to reduce the gross sale price for tax calculation purposes. Common selling expenses include real estate agent commissions, legal fees, escrow fees, and transfer taxes. Other costs, such as title insurance paid by the seller, can also be included.

The net sale price is calculated by subtracting selling expenses from the gross sale price. The capital gain is determined by subtracting the adjusted basis from this net sale price. A positive result represents a capital gain; a negative result indicates a capital loss. For example, if a home sold for $900,000 with $50,000 in selling expenses, resulting in a net sale price of $850,000, and its adjusted basis was $600,000, the capital gain would be $250,000.

Federal Capital Gains Tax on Home Sales

Federal taxation of capital gains from home sales depends on how long the property was owned. Gains from assets held for one year or less are considered short-term capital gains and are taxed at ordinary income tax rates, which can be as high as 37%. Most home sales involve properties held for more than one year, resulting in long-term capital gains. These long-term gains benefit from preferential tax rates, typically 0%, 15%, or 20%, depending on the taxpayer’s overall taxable income.

A significant benefit for homeowners is the primary residence exclusion, outlined in Internal Revenue Code Section 121. This exclusion allows eligible taxpayers to exclude a substantial portion of their capital gain from taxation. To qualify, a homeowner must meet both an ownership test and a use test: they must have owned the home for at least two years and used it as their primary residence for at least two years during the five-year period ending on the date of sale. These two years do not need to be consecutive.

The exclusion amounts allow single filers to exclude up to $250,000 of capital gain and married couples filing jointly to exclude up to $500,000. This exclusion directly reduces the amount of taxable capital gain, rather than reducing the tax itself. For example, a married couple selling their primary residence with a $600,000 capital gain could exclude $500,000, leaving only $100,000 subject to federal capital gains tax.

There are exceptions to the two-year rule that may allow for a partial exclusion. These apply in cases of unforeseen circumstances, such as a change in employment, health issues, or divorce, which necessitate selling the home before the full two-year period is met. In such situations, the exclusion amount is prorated based on the portion of the two-year period the homeowner met the eligibility criteria.

In addition to the standard capital gains tax, high-income earners may also be subject to the Net Investment Income Tax (NIIT). This 3.8% tax applies to net investment income, which includes capital gains from the sale of a home, for individuals with modified adjusted gross income exceeding certain thresholds. The NIIT is applied to the lesser of the net investment income or the amount by which modified adjusted gross income exceeds the applicable threshold.

California Capital Gains Tax on Home Sales

California takes a distinct approach to taxing capital gains from home sales compared to the federal system. The state does not have separate, preferential tax rates for long-term capital gains. All capital gains, regardless of how long the asset was held, are treated as ordinary income and are added to a taxpayer’s other income for state income tax purposes. This means capital gains from a home sale are taxed at the same progressive state income tax rates that apply to wages, salaries, and other forms of income.

California’s income tax rates are progressive. When a significant capital gain from a home sale is added to a taxpayer’s other income, it can push them into a higher state income tax bracket, resulting in a greater overall tax liability for the year.

While California does not have its own primary residence exclusion equivalent to the federal Section 121, the state’s tax system conforms to federal adjusted gross income (AGI). If a capital gain from a home sale is excluded from federal taxable income under Section 121, that gain is also effectively excluded for California state income tax purposes. Since California often starts its income tax calculation with federal AGI, any gain not included in federal AGI due to the primary residence exclusion is consequently not included in the income subject to California state tax.

For homeowners realizing a substantial capital gain not fully covered by the federal exclusion, consider the need for estimated tax payments to California. Since income tax is a pay-as-you-go system, significant untaxed income, such as a large capital gain, may require quarterly estimated tax payments to avoid underpayment penalties. These payments help ensure taxpayers meet their state tax obligations throughout the year, rather than facing a large tax bill and potential penalties at tax filing time.

Reporting the Sale

After determining the capital gain and tax implications, the next step involves reporting the home sale on the appropriate tax forms. The closing agent, such as the title company or escrow company, issues Form 1099-S, “Proceeds From Real Estate Transactions,” to both the seller and the Internal Revenue Service. This form reports the gross proceeds from the sale of the real estate, providing a baseline for the IRS to track property transactions.

For federal tax purposes, the sale of a home is reported on Schedule D, “Capital Gains and Losses,” and Form 8949, “Sales and Other Dispositions of Capital Assets.” Form 8949 lists the details of the sale, including the date acquired, date sold, gross sales price, and the adjusted basis. The information from Form 8949 then flows to Schedule D, where the capital gain or loss is calculated and any applicable primary residence exclusion is applied. The net taxable gain from Schedule D is then carried over to Form 1040, “U.S. Individual Income Tax Return,” to be included in the taxpayer’s overall income calculation.

Similarly, for California state tax purposes, the sale must be reported on the relevant state forms. Taxpayers use California Schedule D (Form 540), “Capital Gain or Loss Adjustment,” to report capital gains and losses. This form aligns with federal reporting, taking into account any federal exclusions that effectively reduce the taxable gain for state purposes. The information from the California Schedule D is then transferred to Form 540, “California Resident Income Tax Return,” to determine the state income tax liability.

Maintaining accurate records is important for tax reporting. Homeowners should retain all documentation related to the purchase of the home, including closing statements and receipts for any qualified capital improvements made over the years. Documentation related to the sale, such as the final closing statement and Form 1099-S, should also be kept. These records are important for accurately calculating the adjusted basis and capital gain, and for substantiating reported figures in case of inquiry or audit.