There’s no escaping taxes in some form, and especially when it comes to the sale of the cornerstone asset of most people’s lives that is a house. In California or anywhere else in the U.S., there are a number of tax obligations and regulations at both the state and federal levels that you need to keep in mind if you sell your own home.
This guide covers the essential facts and rules you need to know so that you can make sure all your Ts are crossed and I’s dotted on one thing with which you’d probably want to avoid cutting corners.
California’s capital gains taxes
One of the fundamental taxes that apply to most home sales throughout the country is the capital gains tax. This applies to profits earned from almost any asset that appreciates in value and it certainly applies to many home sales. In other words, if you manage to sell your house for more than you paid for it, the difference between your buy price and your sale price, also known as the “basis” will come with a capital gains tax.
The IRS will charge you a capital gains tax on your California home sale and so too will the state of California through its Franchise Tax Board (FTB). The FTB sticks to IRS rules on capital gains taxes for the sale of a home and follows the same exemptions. These rules work as follows:
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You may have exemptions on your principal home
There are exemptions on the capital gains tax for selling your main home that applies if you’ve owned and used the property for at least 2 years out of the 5 previous years. These apply to only one home at a time and the property in question can include any of the following:
- Independent houses
- Mobile homes
- Cooperative development homes
You are allowed to avoid reporting the sale of your home if your gain from selling was below $250,000 for you individually. Gains over $250,000 are taxable at the going capital gains tax minus any possible deductions. This exemption doubles to $500,000 if you shared the house with a partner through marriage or if they were a formal registered domestic partner. However, you and your partner would have had to file a joint tax return for the year in which you conducted your home sale.
For both the individual and partnered exemptions, you must have owned and occupied the house or home for at least 2 out of the last 5 years and must have not used the exclusions described above at any time in the last two years. In the case of claiming a deduction with a partner, neither of you should have claimed exclusions on a home sale at any time during the previous two years.
You can also deduct any upkeep/improvement expenses that you put into your house during the time you’ve owned it from your capital gains on a sale.
Does California have a separate capital gains tax rate?
Aside from filing the relevant federal capital gains Tax forms, you need to also file a California Capital Gain or Loss Schedule D 540 form package if your home sale price created a gain for you that was above the $250,000 or $500,000 exclusion limits. You should file these with your next annual tax return after the sale of your house. California’s FTB offers these forms here and their instructions here.
Keep in mind that you’ll also need to keep receipts for your home purchase, sale and any intermediate upkeep costs in case the IRS or the FTB ask for these to corroborate your claimed amounts.
To give you a basic example of how the exclusions work, consider the following: If you live without a partner and own a house in Los Angeles that you bought 10 years ago for $500,000 and then sell it 2022 for $1,000,000, you can exclude $250,000 of that from your $500,000 in gains when it comes to your next tax filing.
This means that you’ll only need to pay taxes on $250,000. If you happen to have lived with a partner in the house for 2 of the last 5 years and neither you nor they have filed their own exclusion in the last 2 years, you and that person won’t have to pay any capital gains taxes on your $500,000 windfall.
Keeping property tax in mind
Presumably, you’ve been paying property taxes on your California home for every year in which you’ve owned it. If you haven’t or if you’ve missed a payment, you need to explain this to the buyer and come to an agreement with them on discounting the outstanding tax amount from the sale price. You can pro-rate any unpaid property taxes with your buyer until you finish the escrow on the house sale.
Interestingly, California has property taxes that are below the national average across the country. In the state, the effective average tax rate is 0.74%.
Transfer taxes exist too
In case you thought your only tax debts for your house sale are to the state and to the Federal Government, we have a surprise for you; there are also transfer taxes that you might need to pay at the county or city level for a home sale.
For example, the California cities of Los Angeles, San Francisco and Riverside all collect their own transfer taxes on home sales. You should check with your city or county tax offices to see what these transfer tax amounts are and how they apply.
Typically, transfer tax payments can be negotiated between you they buyer and your seller. In some parts of California, it’s more traditional for the buyer to pay them while in other parts of the state, the seller should cover this tax. If you’re using a real estate or listing agent for your home sale, you can ask them what the general rule in your area is.
What to know about federal and other tax obligations on a home sale
As we mentioned above, federal tax exemptions and taxes on home sales apply in California too. These are the same as the state tax exemptions but the IRS offers its own special forms for declaring a house sale capital gains tax. These are called Capital Gains and Losses Schedule D and include IRS forms 1040 and 1040-D.
Remember that you don’t have to report the sale of your house or your capital gains on it if any of these conditions is the case:
- The gain you made from your home sale was less than $250,000 for you individually or less than $500,000 for you with a formal partner who filed jointly with you on your last tax return.
- You’ve occupied your house for 2 of the last 5 years and neither you nor your partner has used an exclusion in the last two years.
- The IRS hasn’t issued you with Form 1099-S for reporting proceeds from real estate transactions.
Also remember that capital gains tax exemptions DON’T apply to investment properties that you can’t prove to have not occupied or which aren’t your primary home. Houses in California that you bought only as investment properties won’t be covered by IRS or DTB exemption amounts.
What about selling a home you inherited?
If you’ve inherited your home, things change a little bit for both state and federal capital gains taxes. Basically, if you inherit a home and occupied it during two of the last 5 years, your tax gains will be based on its fair market value (FMV) at the time you were given the house vs. your own sale price. You’ll have to pay capital gains on anything over $250,000 or $500,000 (with jointly filing partner).
If you receive a home and sell within less than the time allowed for exemptions of any kind, your capital gains will be the difference between your sale price and the FMV of the house when it was given to you and you’ll be liable for paying them completely.
So for example, if you received a home from a relative who originally bought it for $100,000 2 decades ago, but it’s assessed value when the home was bequeathed to you is $400,000, and you sell the house a year after that for $600,000, your taxable capital gains will be $200,000.
How to handle your home sale professionally
When you’re selling your house in California, you’ll have to handle all of your transactions with plenty of legal and financial paperwork. It’s important that you keep all of this paperwork and all receipts from any costs, commissions, sales and purchases.
In fact, you should also have kept receipts on house maintenance expenses from the day you bought your house right through to the day you sell your house. All of these can be used for deductions from your taxable capital gains.
Keep in mind that California state law makes it obligatory to handle all of your transactions for a real estate deal of any kind in writing. This will help protect both you and your buyer from liability issues and let you keep a clear accounting of transactions for the sake of tax laws or possible civil lawsuits and disagreements.
If you want to sell your California home as of today, you should also find out just what kind of price you can expect to get for it. This will let you have an idea of the kinds of capital gains you might expect and the taxes you’ll have to pay on them. Use iBuyer to find out in minutes just what kind of price a trusted buyer is willing to pay for your own home.