Do You Pay Capital Gains Tax When You Sell Your Home in California?

The home sale exclusion

The IRS lets you exclude up to $250,000 of gain from the sale of your main home, or up to $500,000 if you file jointly with your spouse. To qualify, you generally must have:

• Owned the home for at least 2 of the 5 years before the sale, and
• Lived in it as your main home for at least 2 of those 5 years, and
• Not excluded gain on another home sold within the prior 2 years.

The two years of ownership and use don't have to be the same two years. For joint filers claiming $500,000, either spouse can meet the ownership test, but both must meet the use test.

What California does

The Franchise Tax Board says California conforms to the IRS rules and allows the same exclusion. The difference is what happens to gain above it. California has no special capital gains rate; gains are taxed as ordinary income under the state's regular rates. So in a high-value market like Westlake Village or Thousand Oaks, the state tax on a large gain can be significant.

How to estimate your gain

1. Start with your basis: what you paid for the home, plus certain purchase costs, plus capital improvements such as additions and decks. Ordinary repairs don't count.
2. Figure the amount realized: the sale price minus selling costs such as commissions, title and escrow fees, and money spent preparing the home for sale.
3. Subtract: amount realized minus adjusted basis is your gain.
4. Apply the exclusion: up to $250,000 or $500,000 if you qualify.

Keep records of improvements. Over 20 or 30 years of ownership, receipts for a kitchen remodel or a room addition can make a real difference.

If you don't meet the 2 year rules

You may qualify for a partial exclusion if the main reason for the sale is a job change, health, or an unforeseen circumstance such as a death or divorce. The exclusion is generally prorated by how much of the two years you met. For example, one year of ownership and use could allow up to $125,000 for a single filer.

Inherited homes follow different rules. Their basis is generally the fair market value at the date of death.

A worked example

Round numbers, for illustration only. A married couple bought their Thousand Oaks home for $400,000 and added $100,000 in capital improvements over the years, for a basis of $500,000. They sell for $1,300,000 and pay $70,000 in selling costs, so the amount realized is $1,230,000.

Their gain is $1,230,000 minus $500,000, or $730,000. They qualify for the $500,000 joint exclusion, so $230,000 is taxable. The IRS taxes it at capital gains rates, and California taxes it as ordinary income at their regular state rate.

Without the improvement records, their basis would be $400,000 and the taxable gain $330,000. Receipts matter.

Withholding at closing: Form 593

California generally requires escrow to withhold 3 1/3 percent of the sales price on real estate sales, as a prepayment of the seller's state income tax. There are exemptions. No withholding is required when the property was last used as your principal residence, when the sales price is $100,000 or less, or when you have a loss or zero gain. You certify the exemption on Form 593.

You also must report the sale on your federal return if you receive Form 1099-S, even if all of the gain is excluded.

This is general information, not legal or tax advice. Talk to a California attorney, a CPA, or a HUD-approved housing counselor about your situation.

Plan the sale with the tax in mind

Timing can matter. Selling a few months after you hit the two year mark, or before you pass the three years since moving out of a former home, can change the result. Joe Hall works with CPAs and will help you line up the sale with their advice. See selling with Joe or get in touch.