Capital gains tax can significantly impact your bottom line when selling a rental property, especially in California where both state and federal taxes apply to your profits. Since California treats capital gains as regular income, your tax burden can easily exceed 30% depending on your income and property gains.
Understanding how this tax works is essential for landlords, investors, and everyday property owners looking to maximize returns and avoid costly surprises.
In this guide, we’ll break down how capital gains tax is calculated in California, how rental property sales are treated, and what strategies you can use to reduce what you owe. Whether you’re selling your first rental or managing a larger portfolio, this article will help you make informed, tax-smart decisions.
What Is Capital Gains Tax in California?
Capital gains tax is what you owe on the profit made from selling a property for more than its purchase price. This profit (called a capital gain) is the difference between your selling price and your adjusted cost basis.
At the federal level, capital gains are taxed based on how long you’ve owned the property (short-term vs. long-term). But California treats things differently.
The state doesn’t distinguish between short- and long-term gains or between capital gains and regular income. Instead, all profits are taxed as ordinary income, with rates ranging from 1% to 13.3%.
Combined with federal capital gains tax rates (up to 20%) and possible investment surcharges, your total tax burden can easily exceed 30%.
California Capital Gains Calculator
Types of Capital Gains on Rental Property
The way your capital gain is taxed depends on how long you’ve owned the property. At the federal level, the IRS separates gains into short-term and long-term categories, each with different tax rates. But in California, there’s no such distinction: all gains are taxed as regular income.
Short-Term Capital Gains
Short-term gains apply when you sell a rental property you’ve owned for one year or less. These are taxed at your ordinary federal income tax rate, which can be as high as 37%.
For high-income earners in California, this can create the maximum tax burden, as you’re paying both the top federal rate and the state’s highest income tax rate of 13.3%.
Long-Term Capital Gains
If you’ve owned the property for more than one year, your profit qualifies for the federal long-term capital gains tax rates: 0%, 15%, or 20%, depending on your income.
However, California doesn’t follow this structure. Instead, long-term gains are still taxed as regular income at the state level, meaning rates up to 13.3% still apply, regardless of how long you held the property.
How is Capital Gains Tax Calculated on Rental Property in California?
To figure out how much capital gains tax you’ll owe when selling a rental property in California, you’ll need to calculate your adjusted cost basis, factor in any depreciation recapture, and subtract that from your sale price.
Here’s what goes into your adjusted cost basis:
- Purchase price – what you originally paid for the property
- Improvements – upgrades or renovations that add long-term value
- Selling costs – agent commissions, closing costs, legal fees, etc.
- Depreciation claimed – the amount you’ve written off over time (subject to recapture)
Once you subtract your adjusted cost basis and selling costs from the sale price, you’re left with your capital gain.
Depreciation Recapture and Its Impact
Depreciation reduces your taxable income each year, but the IRS requires you to “pay it back” when you sell. This is called depreciation recapture, and it’s taxed at a flat 25% rate, regardless of your income bracket.
Example Breakdown:
- Purchase price: $300,000
- Improvements: $30,000
- Selling costs: $20,000
- Total cost basis: $350,000
- Sale price: $500,000
- Capital gain: $150,000
- Depreciation claimed: $40,000
- Depreciation recapture tax: $10,000 (25% of $40,000)
- Remaining gain subject to capital gains tax: $110,000
Both the $10,000 in recapture and the $110,000 in remaining gain will be taxed at both the federal and state levels.
California Capital Gains Tax Rates for 2025
California doesn’t have a separate capital gains tax. Instead, any profit from the sale of a rental property is taxed as regular income under the state’s progressive tax system.
In 2025, California has nine income tax brackets, ranging from 1% to 12.3%. If your total taxable income exceeds $1 million, you’ll also owe an extra 1% mental health services tax, bringing the top marginal rate to 13.3%.
Here’s how the total capital gains tax burden breaks down for most California sellers:
- Federal long-term capital gains tax: 15% or 20%, depending on your income bracket
- California state income tax: 1% to 13.3%, based on total income (including your gain)
- Net Investment Income Tax (NIIT): An additional 3.8% may apply if your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly)
In total, your combined tax rate on capital gains could range from 20% to over 35%, depending on your income.
Capital Gains Tax Example: Selling a Rental Property in California
Understanding how capital gains tax applies in real-world scenarios can help you prepare for what you might owe and avoid unpleasant surprises at tax time. Let’s walk through a simplified example of how these taxes are calculated when selling a rental property in California.
Property Details:
- Purchase price: $300,000
- Improvements made: $50,000
- Sale price: $550,000
- Selling costs (e.g., agent fees, closing costs): $25,000
- Depreciation claimed: $45,000
Capital Gains Calculation:
- Adjusted basis = $300,000 + $50,000 = $350,000
- Raw gain = $550,000 – $350,000 = $200,000
- Taxable gain after selling costs = $200,000 – $25,000 = $175,000
Taxes Owed:
- Depreciation recapture = 25% of $45,000 = $11,250
- Federal long-term capital gains tax (15%) = 15% of $130,000 = $19,500
- Estimated California income tax (10%) = $17,500
Estimated Total Tax Bill: ~$48,250 on $175,000 of gain
This example shows how quickly capital gains taxes can accumulate, especially in California, where profits are taxed as ordinary income. For rental property owners, careful tax planning and understanding these costs in advance can make a significant difference in your net proceeds.
How to Minimize Capital Gains Tax on Rental Property
Minimizing capital gains tax when selling a rental property requires careful planning and strategy. Property owners can significantly reduce tax implications of selling rental property in California through various tax-advantaged methods.
Hold for Over One Year
One of the simplest ways to minimize your tax burden is by holding the property for more than a year. Long-term capital gains are taxed at lower rates compared to short-term gains, which are taxed as ordinary income. This strategy can help reduce the rate at which your profits are taxed.
Sell in a Low-Income Year
If you can afford to wait, timing your sale during a year when your income is lower could reduce the amount of tax you owe. If your overall income is lower, you might fall into a lower tax bracket, which could result in a lower capital gains tax rate.
Increase Your Cost Basis
Document and deduct qualifying improvements, closing costs, and fees to increase your property’s basis. The higher your basis, the lower your taxable gain. Keep detailed records of all improvements that add value to the property, such as kitchen renovations, new roofing, or upgraded electrical systems.
Offset Gains with Losses
Use other capital losses to reduce your taxable gains through a strategy called tax-loss harvesting. If your losses exceed your gains, you can also offset your ordinary income by up to $3,000 ($1,500 for those married filing separately). Any additional losses can be carried forward to future years.
1031 Exchange: How to Defer Capital Gains Tax in California
One of the most effective ways to defer capital gains tax when selling a rental property in California is by completing a 1031 exchange. This IRS-approved strategy lets you reinvest your profits into another investment property without paying taxes on your gain at the time of sale.
To qualify for a 1031 exchange, you must:
- Reinvest in a like-kind property (must also be for investment or business use)
- Identify the new property within 45 days of selling your current one
- Close on the replacement property within 180 days
- Use a qualified intermediary to hold the proceeds (you can’t take possession of the funds)
When done correctly, a 1031 exchange allows you to postpone capital gains tax indefinitely, as long as you continue rolling over your investments. While this doesn’t eliminate your tax obligation, it can help you preserve equity and grow your real estate portfolio more efficiently.
Other Tax Breaks for California Property Owners
Beyond standard deductions and reinvestment tactics, there are a few advanced strategies that can help reduce the tax implications of selling rental property in California, especially in more complex ownership scenarios.
Primary Residence Exclusion
If you’ve lived in your rental property as your primary residence for at least 2 of the past 5 years, you may qualify for the federal Section 121 exclusion. This allows you to exclude up to $250,000 in capital gains if single or $500,000 if married filing jointly.
While this approach requires careful planning, it’s a highly effective way to reduce the tax burden associated with selling a rental property in California, especially if your property has appreciated significantly.
Self-Directed IRAs
Some investors use self-directed IRAs to buy and hold real estate within their retirement accounts. When structured properly, this can defer or even eliminate capital gains tax since the property is held under a tax-advantaged retirement vehicle.
Because this strategy involves strict IRS rules and potential penalties, it’s best suited for seasoned investors who fully understand the tax implications of alternative real estate ownership structures. Always consult a tax advisor before using a self-directed IRA for rental property.
FAQs About Capital Gains Tax in California
These common questions can help you make informed decisions about capital gains on rental property and avoid costly mistakes.
Do I Have to Pay Taxes on Gains From Selling My House in California?
Yes. If it’s your primary residence, you may qualify for an exclusion of up to $250,000 (or $500,000 if married filing jointly), as long as you meet ownership and use requirements. Rental properties generally don’t qualify unless they’ve been converted into your primary home.
How Do I Avoid Capital Gains Tax in California?
You can’t eliminate it entirely, but you can reduce or defer it by using strategies like:
- 1031 exchanges
- Selling in a low-income year
- Increasing your cost basis with documented improvements
- Converting a rental to a primary residence (if eligible)
Are There Penalties for Incorrectly Reporting Capital Gains?
Yes. Both the IRS and California Franchise Tax Board can assess penalties and interest for underreporting or failing to report capital gains. Keeping detailed, accurate records is the best way to stay compliant.
Can I Deduct Losses Against Capital Gains?
Yes. Capital losses offset gains on a dollar-for-dollar basis. If your losses exceed your gains, you can apply up to $3,000 of the excess to reduce ordinary income per year and carry the rest forward.
Do I Have to Pay Capital Gains Tax If I Inherit Property?
Not immediately. Inherited property receives a stepped-up basis to its fair market value at the time of inheritance. You only pay capital gains tax on the appreciation that occurs after you inherit and later sell the property.
How Much Capital Gains Tax Will I Pay on $250,000?
It depends on your income and filing status. Combined federal and California tax rates can range from around 15% to over 35%, meaning you could owe between $37,500 and $87,500 on a $250,000 gain.
Who Pays 20% Capital Gain Tax?
According to the IRS, a 20% long-term capital gains tax rate applies to the portion of your gain that exceeds the threshold for the 15% bracket.
Thresholds based on 2025 IRS inflation-adjusted figures as reported by Kiplinger:
- $553,400+ for single filers
- $600,050+ for married filing jointly
- $566,700+ for heads of household
If your taxable income is below these levels, your gain is taxed at 0% or 15%. The 20% rate only kicks in on the excess over the threshold.
Sell Your House to Osborne Homes and Skip Capital Gains Frustrations
If you’re looking to sell your rental property and want to avoid the stress of dealing with capital gains tax in California, selling your house directly to Osborne Homes might be the right solution.
When you sell directly to Osborne Homes:
- There’s no need to list your home, make repairs, or wait for buyer financing
- You can close quickly and walk away with cash in hand
- You avoid many of the typical delays and stress, including those related to capital gains tax planning
This option is especially helpful if you’re selling a house with tenants in California. Osborne Homes is experienced in handling occupied properties and tenant transitions, making your sale as hands-off as possible.
Ready to get a fair cash offer? Contact us to get started with a no-obligation consultation.
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