Capital gains tax on real estate in California can reach a combined federal and state rate above 37% on a single sale, because California taxes the entire profit as ordinary income at rates up to 13.3% with no discount for long holdings, and that stacks on top of federal capital gains tax that tops out at 23.8% for high earners. The gap between what you paid and what you sold for sets the taxable gain, but exclusions, basis adjustments, and deferral strategies can shrink or postpone the bill considerably.
How California Treats the Gain
California does not distinguish between short-term and long-term capital gains. Under Revenue and Taxation Code Section 17041, all realized profit from a property sale is added to your other income for the year and taxed through the state’s progressive brackets. The top marginal rate of 12.3% kicks in well below the million-dollar mark for most filing statuses, and the Mental Health Services Act adds another 1% on every dollar of taxable income above $1 million, bringing the effective ceiling to 13.3%.
That flat treatment is what makes selling appreciated California property so expensive compared to other states. A home you held for 20 years gets no state-level discount. The same 13.3% top rate applies whether you flipped a house in six months or sold a rental you owned for decades.
Federal Rates Depend on How Long You Owned It
Federal law does reward patience. If you owned the property for more than one year before selling, the profit qualifies for long-term capital gains rates of 0%, 15%, or 20%. Property held one year or less is taxed at ordinary income rates, which can reach 37% at the federal top bracket. The rate you pay on long-term gains depends on your total taxable income for the year. For 2026, the thresholds are:
- 0% rate: Taxable income up to $49,450 (single) or $98,900 (married filing jointly).
- 15% rate: Taxable income from $49,451 to $545,500 (single) or $98,901 to $613,700 (married filing jointly).
- 20% rate: Taxable income above $545,500 (single) or $613,700 (married filing jointly).
The holding period starts the day after you acquired the property, so timing matters on recent purchases.1Internal Revenue Service. Topic No. 409, Capital Gains and Losses Most California sellers dealing with real appreciation have held long enough to qualify for the lower long-term rates.
The 3.8% Net Investment Income Tax
High-income sellers face a 3.8% federal surtax on net investment income, including real estate gains. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.2Internal Revenue Service. Net Investment Income Tax These thresholds are not adjusted for inflation, so they catch more taxpayers every year.
Most California homeowners selling property worth enough to generate a substantial gain will clear these thresholds in the year of the sale. The surtax pushes the top federal rate on long-term gains to 23.8%, which combines with California’s 13.3% for a potential ceiling of 37.1%. Any gain from a home sale that exceeds the primary residence exclusion counts as net investment income for this purpose.3Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
Depreciation Recapture on Rentals
If you claimed depreciation deductions on rental or investment property, a portion of your gain is taxed at a separate federal rate. The IRS taxes the profit attributable to depreciation previously taken (unrecaptured Section 1250 gain) at a maximum rate of 25%, higher than the 15% long-term rate most sellers face.4Internal Revenue Service. Treasury Decision 8836 Only the gain up to the total depreciation you claimed gets this treatment; anything beyond that is taxed at the regular long-term rates.
California has no separate depreciation recapture rate. The recaptured amount flows into your ordinary income and gets taxed at whatever state bracket applies. For a landlord who depreciated a property for 15 or 20 years, the recapture amount can be substantial, and sellers are often caught off guard by it.
The Primary Residence Exclusion
The most powerful tax break available to California homeowners is the federal Section 121 exclusion, which California also recognizes under Revenue and Taxation Code Section 17152.5California Legislative Information. California Revenue and Taxation Code RTC 17152 If you sell your primary residence and meet the ownership and use requirements, you can exclude up to $250,000 of profit from both federal and state income tax. Married couples filing jointly can exclude up to $500,000, provided both spouses lived in the home for at least two of the five years before the sale.6Office of the Law Revision Counsel. 26 USC 121 Exclusion of Gain From Sale of Principal Residence
The two years of residency do not need to be consecutive. You could live in the home for 14 months, move out for a year, then move back for 10 months and still qualify. The exclusion is available once every two years, so you cannot sell two homes within a 24-month window and claim it on both.
Partial Exclusion for Qualifying Circumstances
Sellers who do not meet the full two-year requirement may still qualify for a partial exclusion if they sold because of a job relocation, a health issue, or an unforeseen event. A work-related move generally qualifies when your new workplace is at least 50 miles farther from the home than your old one. Health-related moves qualify when a doctor recommends a change of residence or you need to care for a family member with a serious condition. Unforeseen events include natural disasters, divorce, job loss, and the death of a co-owner.7Internal Revenue Service. Publication 523, Selling Your Home
The partial exclusion is prorated by how much of the two-year requirement you met. One year of residence before a qualifying job transfer gets you half the maximum: $125,000 for a single filer or $250,000 for a married couple filing jointly.
Figuring Your Taxable Gain
The taxable gain is not simply what you sold for minus what you paid. Two adjustments work in your favor: raising your cost basis and subtracting selling expenses from the sale price.
Adjusted Cost Basis
Start with your original purchase price and add the cost of capital improvements that extended the property’s useful life or added value. A new roof, an added bathroom, a seismic retrofit, and a complete kitchen remodel all qualify. Routine maintenance and repairs do not.8Internal Revenue Service. Publication 551, Basis of Assets Certain closing costs from your original purchase, including title insurance premiums and recording fees, also increase your basis.
You must reduce the basis by any depreciation you claimed or were entitled to claim. If you used part of your home as a rental or home office and took depreciation deductions, those come off the basis even if they saved you little in taxes at the time. Casualty loss deductions and insurance reimbursements for property damage also reduce the basis.
Selling Expenses
Selling expenses come off the sale price to arrive at the amount actually realized. These include real estate agent commissions, legal fees, advertising costs, transfer taxes you paid as the seller, and any loan charges you covered that were normally the buyer’s responsibility.7Internal Revenue Service. Publication 523, Selling Your Home In California, where a standard commission runs 5% to 6% of the sale price, these deductions can meaningfully shrink the taxable gain.
Stepped-Up Basis for Inherited Property
If you inherited the property rather than buying it, your cost basis is generally the fair market value on the date the previous owner died, not what they originally paid.8Internal Revenue Service. Publication 551, Basis of Assets A home purchased in 1975 for $80,000 and worth $1.2 million at the owner’s death would get a new basis of $1.2 million in the heir’s hands. Sell it a year later for $1.25 million, and the taxable gain is only $50,000.
California is a community property state, which creates an additional benefit. When one spouse dies, both halves of community property receive a stepped-up basis, not just the decedent’s half. A couple who bought a home together for $200,000 that is worth $1.4 million at one spouse’s death gets a full basis of $1.4 million for the surviving spouse. In common-law states, only the decedent’s half would be stepped up. This double step-up is one of the most significant and underused tax advantages in California estate planning.
Deferring the Tax With a 1031 Exchange
Section 1031 of the Internal Revenue Code lets investors swap one piece of investment or business real estate for another without paying capital gains tax at the time of the swap. The gain rolls into the replacement property, deferring the tax bill until you eventually sell without doing another exchange. California conforms to the federal 1031 rules, so the deferral applies at both levels.
The definition of “like-kind” is broader than most people expect. Any real property held for investment or business use generally qualifies, regardless of property type. You can exchange a rental duplex for a commercial warehouse or vacant land for an apartment building. Property held primarily for resale, such as a house you bought to flip, does not qualify. Personal residences are also excluded.9Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
Two deadlines are absolute. You must identify potential replacement properties in writing within 45 days of selling the original property, and you must close on the replacement within 180 days. Missing either deadline makes the entire gain taxable in the year of the original sale. A qualified intermediary must hold the proceeds during the exchange; if you take possession of the funds, even briefly, the exchange fails.10Office of the Law Revision Counsel. 26 USC 1031 Exchange of Real Property Held for Productive Use or Investment
California’s Extra Tracking Requirement
California adds one wrinkle that catches investors off guard. If you exchange California property for replacement property in another state, you must file Form FTB 3840 with the Franchise Tax Board in the year the exchange closes and every subsequent year until you recognize the deferred gain. This lets California track deferred gains that leave the state so it can collect its share when the gain is eventually recognized. Forgetting to file the form can create penalties even though no tax is currently due.
Spreading the Gain With an Installment Sale
When a 1031 exchange is not practical, an installment sale offers another way to manage the tax hit. If you finance part of the purchase price for the buyer and receive payments over multiple years, you report only the portion of the gain received each year rather than the full amount at closing.11eCFR. 26 CFR 15a.453-1 Installment Method Reporting for Sales of Real Property and Casual Sales of Personal Property This can keep your income below the thresholds where the highest federal and California rates apply.
The installment method is the default for any real estate sale where at least one payment arrives after the tax year of the sale. You can elect out of it on your return if you prefer to pay all the tax upfront. The trade-off is carrying the credit risk of buyer default in exchange for tax savings. Interest on the installment note is taxed as ordinary income separately from the gain portion.
What Escrow Withholds at Closing
California collects a prepayment toward your state tax bill at the time of sale. Under California Code of Regulations Section 18662-3, escrow agents withhold 3⅓% of the total sales price and remit it directly to the Franchise Tax Board.12Legal Information Institute. California Code of Regulations Title 18 Section 18662-3 – Real Estate Withholding The seller documents the transaction on Form 593.
Several transactions are exempt. No withholding is required when the sale price is $100,000 or less, the property is the seller’s principal residence qualifying under Section 121, or the property is in foreclosure.13Franchise Tax Board. Real Estate Withholding Sellers can also elect an alternative calculation based on the estimated gain rather than the full sales price, which reduces the amount held when the gain is a small fraction of the price. The withheld amount is credited against your actual state tax liability when you file your California return; if it exceeds what you owe, you claim the difference as a refund.
Estimated Tax Payments After the Sale
Selling property often creates a one-time income spike that regular wage withholding will not cover. Both the IRS and the Franchise Tax Board expect you to pay taxes as you earn income, not just at year-end. Wait until filing season and you may owe an underpayment penalty on top of the tax itself.
The federal safe harbor lets you avoid the penalty if you paid at least 90% of the current year’s tax or 100% of the prior year’s tax through withholding and estimated payments. If your adjusted gross income exceeded $150,000 in the prior year, that second threshold rises to 110%.14Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty For 2026, federal estimated tax payments are due April 15, June 15, September 15, and January 15 of the following year.15Internal Revenue Service. Publication 509, Tax Calendars
California follows a similar quarterly structure. The state withholding collected at closing through Form 593 counts toward your California estimated tax obligation, but for large gains it often will not cover the full amount owed. Running the numbers shortly after closing, rather than waiting for year-end, is the single most effective way to avoid surprises.