Capital Gains Tax When Selling a Home in California

Selling a home or investment property in California triggers one of the most significant tax events most people will ever experience. California is one of the highest-taxed states in the nation, and when you combine federal capital gains tax with California's state income tax — which treats capital gains as ordinary income — the total tax bite can reach 33.3% or more on your profit. Understanding how these taxes work, what exemptions are available, and how to legally minimize your tax burden is critical before you sign a purchase agreement.

Capital gains tax applies to the profit you make when selling an asset — in this case, real estate. Your capital gain is calculated as the difference between your adjusted basis (what you paid for the property plus qualifying improvements and certain costs) and your net sale price (the sale price minus selling costs like commissions and closing fees). If you bought your Sacramento home for $300,000, put $50,000 into improvements, and sell it for $600,000 with $30,000 in selling costs, your capital gain would be $220,000.

The tax treatment of your capital gain depends on two primary factors: how long you owned the property and whether it was your primary residence. Properties held for more than one year qualify for long-term capital gains rates, which are significantly lower than short-term rates. Properties held for one year or less are taxed at your ordinary income tax rate. For California residents, this distinction matters less at the state level because California taxes all capital gains as ordinary income regardless of holding period.

For homeowners in the Sacramento area where property values have appreciated significantly over the past decade, the tax implications of selling can be substantial. A home purchased in Roseville or Folsom for $350,000 in 2015 that sells for $700,000 today could generate a capital gain of $300,000 or more — and without proper planning, the tax bill could exceed $60,000. That's why understanding your options before selling is so important.

At the federal level, long-term capital gains are taxed at three tiers based on your taxable income. For 2025, single filers pay 0% on gains if their total taxable income is below $48,350, 15% on gains for income between $48,350 and $533,400, and 20% on gains for income above $533,400. Married couples filing jointly pay 0% below $96,700, 15% between $96,700 and $600,050, and 20% above $600,050. Additionally, high-income taxpayers may owe the 3.8% Net Investment Income Tax (NIIT) on capital gains if their modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly).

The most powerful tax benefit available to homeowners is the Section 121 exclusion under the Internal Revenue Code. This provision allows you to exclude up to $250,000 in capital gains from the sale of your primary residence if you're single, or up to $500,000 if you're married filing jointly. To qualify, you must have owned the home and used it as your primary residence for at least two of the five years preceding the sale. This is commonly referred to as the 2-of-5-year rule.

The Section 121 exclusion is remarkably flexible. The two years of ownership and two years of use don't need to be consecutive. You could live in the home for the first two years, rent it out for two years, and sell it in the fifth year and still qualify. However, if you've used the exclusion on another home sale within the past two years, you cannot use it again. For most homeowners in Sacramento County selling their primary residence, the Section 121 exclusion eliminates the federal capital gains tax entirely.

If you don't meet the full 2-of-5-year requirement, you may still qualify for a partial exclusion if you sold due to a change in employment, health reasons, or certain other unforeseen circumstances. The partial exclusion is prorated based on the time you did live in the home. For example, if you lived in your Sacramento home for one year out of the required two before needing to sell due to a job relocation, you could exclude up to 50% of the maximum exclusion — $125,000 for a single filer or $250,000 for a married couple.

Short-term capital gains — on properties held for one year or less — are taxed at your ordinary federal income tax rate, which can be as high as 37% for the highest bracket. If you're flipping a property or selling a home you've owned for less than a year, the tax consequences are significantly more severe. Combined with California state taxes, short-term gains can be taxed at over 50% in extreme cases.

Unlike the federal system, California does not offer a preferential tax rate for long-term capital gains. The state treats all capital gains as ordinary income and taxes them at the same rates as wages, salaries, and other earned income. California's income tax rates are progressive, ranging from 1% to 13.3%, with the top rate applying to income over $1,000,000. There is also a 1% mental health services surcharge on income over $1,000,000.

For a homeowner selling a property with a $400,000 capital gain that isn't covered by the Section 121 exclusion — such as an investment property — the California state tax alone could be $40,000 to $53,200 depending on their other income. Add the federal tax of 15% to 23.8% (including the NIIT), and the combined tax bill on a $400,000 gain could exceed $130,000. This is the reality that many rental property owners and real estate investors face in California.

California does conform to the federal Section 121 exclusion for primary residences, which means the same $250,000/$500,000 exclusion that reduces your federal tax also reduces your California tax. However, California does not conform to all federal provisions. Notably, California does not allow the federal Qualified Opportunity Zone deferral, and there are differences in how the state treats installment sales and certain like-kind exchanges.

One often-overlooked aspect of California's tax system is the state's withholding requirement for real estate sales. Under California Revenue and Taxation Code Section 18662, the buyer (or escrow company) is required to withhold 3.33% of the total sale price — not just the gain — and remit it to the Franchise Tax Board (FTB) unless the seller qualifies for an exemption. The most common exemption is for the sale of a primary residence at a price of $733,750 or less. For properties above this threshold or for investment properties, the withholding can be significant. A $600,000 sale would trigger a $19,980 withholding. You can apply for a reduced withholding if the actual tax owed is substantially less, but this requires advance planning.

If you've inherited a home in California, you benefit from what's called a stepped-up basis. Under federal tax law (IRC Section 1014), when you inherit property, your tax basis is reset to the fair market value of the property on the date of the decedent's death — not what the original owner paid for it. This can dramatically reduce or even eliminate your capital gains tax when you sell.

For example, if your parents bought their Sacramento home in 1985 for $120,000 and it was worth $650,000 when they passed away, your basis in the property is $650,000 — not $120,000. If you sell the home for $670,000, your capital gain is only $20,000 rather than $550,000. This step-up in basis saves beneficiaries tens or even hundreds of thousands of dollars in capital gains taxes and is one of the most valuable provisions in the tax code for inherited property.

For community property states like California, there's an additional benefit. When one spouse dies, both halves of community property receive a stepped-up basis — not just the deceased spouse's half. This means the surviving spouse's basis in the entire property is stepped up to its current fair market value, which can be an enormous tax savings if the property has appreciated significantly.

However, California's Proposition 19, which took effect in February 2021, significantly changed the property tax landscape for inherited homes. Under Prop 19, inherited properties that are not used as the beneficiary's primary residence are reassessed to current market value for property tax purposes. Previously, under Propositions 13 and 58, children could inherit their parents' low property tax basis regardless of how they used the property. Now, unless you move into the inherited home as your primary residence within one year of the transfer, you'll face a property tax reassessment that could increase your annual property taxes by thousands of dollars. This reassessment doesn't affect your income tax step-up basis — those are separate issues — but it can make holding inherited property significantly more expensive.

For many people who inherit homes in the Sacramento area, the combination of maintenance costs, property tax increases under Prop 19, and the desire to avoid the hassle of managing an inherited property makes selling the smart financial decision. With the stepped-up basis reducing your capital gains, the tax consequences of selling an inherited home are often minimal. Sierra Property Buyers specializes in purchasing inherited homes quickly and can close before property tax reassessment becomes a burden.

For investment and rental property owners, the Section 1031 like-kind exchange is the most powerful tool for deferring capital gains tax. Under IRC Section 1031, you can sell an investment property and defer all capital gains taxes — both federal and California state — by reinvesting the proceeds into a replacement property of equal or greater value within specific timeframes.

The 1031 exchange has strict rules. You must identify the replacement property within 45 days of closing on the sale of your relinquished property and close on the replacement property within 180 days. The exchange must be facilitated by a Qualified Intermediary (QI) — you cannot touch the sale proceeds at any point during the exchange. The replacement property must be of like-kind, which for real estate simply means any real property held for investment or business use (you cannot exchange into a personal residence).

It's important to note that a 1031 exchange defers taxes — it doesn't eliminate them. When you eventually sell the replacement property without doing another exchange, you'll owe taxes on the total accumulated gain from all properties in the exchange chain. However, many investors do serial 1031 exchanges throughout their lifetime and ultimately pass the properties to heirs, who receive a stepped-up basis that eliminates the deferred gain entirely. This combination of 1031 exchanges during life and a step-up in basis at death is sometimes called the 'swap til you drop' strategy.

If a 1031 exchange isn't feasible — perhaps you need the cash from the sale or can't find a suitable replacement property within the tight timeframes — consider other strategies. An installment sale under IRC Section 453 allows you to spread your capital gain over multiple years by receiving the sale proceeds in installments, potentially keeping you in lower tax brackets. Charitable remainder trusts can provide income tax deductions and spread capital gains over the trust's term. And for primary residences, maximizing the Section 121 exclusion through careful timing of your sale can save up to $132,500 in combined federal and state taxes.

At Sierra Property Buyers, we work with sellers across all tax situations. Whether you're selling a primary residence and want to maximize your Section 121 exclusion, offloading an inherited property with a stepped-up basis, or exploring a 1031 exchange with your rental property, we can structure our purchase to accommodate your tax planning timeline. We always recommend consulting with a qualified CPA or tax attorney before selling — and we're happy to refer you to experienced professionals in the Sacramento area who specialize in real estate taxation.