Understanding Capital Gains: A California Real Estate Owners Guide

Capital gains refer to the profit made from selling a capital asset, such as real estate, at a price

higher than its purchase price. For property owners, particularly in California, understanding capital

gains taxes is essential for effective real estate planning.

Federal Capital Gains Taxes

Federally, capital gains taxes are divided into short-term and long-term gains:

- Short-term gains (property held for one year or less) are taxed at ordinary income rates, ranging

from 10% to 37% depending on your income bracket.

- Long-term gains (property held longer than one year) are typically taxed at 0%, 15%, or 20%,

again depending on your taxable income.

California State Capital Gains Taxes

California does not distinguish between short-term and long-term capital gains. Instead, capital

gains are taxed as ordinary income, with rates ranging up to 13.3%, the highest in the nation. This

makes tax planning crucial for California property owners.

The Forgotten Tax: Depreciation Recapture

When selling investment property, many owners overlook depreciation recapture, a tax imposed on

the portion of the gain attributable to previously claimed depreciation deductions. Federally,

depreciation recapture is taxed at a maximum rate of 25%, and California treats it as ordinary

income.Important: In California, this is in addition to the standard state capital gains tax, effectively creating

two layers of taxation.

Example:

- Suppose you have $50,000 in depreciation recapture:

- Federal: You pay up to 25% on the $50,000.

- California: The same $50,000 is added to your ordinary income and taxed up to 13.3%.

- If your total realized gain is $200,000 (including depreciation recapture):

- California taxes the entire $200,000 gain at ordinary rates, which can range from 9.3% 13.3%,

depending on your income bracket.

Effective planning can help mitigate the impact of this often-forgotten tax.

How to Minimize or Avoid Capital Gains Taxes

1. Primary Residence Exclusion:

- Single homeowners can exclude up to $250,000, and married couples filing jointly can exclude

up to $500,000 of capital gains if they've lived in the home as their primary residence for two of the

past five years.

2. 1031 Exchange:

- This allows investors to defer capital gains taxes by reinvesting the proceeds from the sale into a

"like-kind" property within specific timeframes.

3. Utilizing Trusts and Estates:

- Transferring properties into certain trusts or as part of an estate plan can help minimize or

4. eliminate capital gains taxes through stepped-up basis strategies.4. Qualified Opportunity Zones:

- Investing gains into designated economically distressed areas can defer and even reduce capital

gains taxes significantly.

5. Charitable Donations:

- Donating appreciated property to a charity can offer substantial tax deductions and eliminate

capital gains taxes.

Take Control of Your Capital Gains

Effective real estate planning, especially in California, requires understanding how capital gains

impact your finances. Utilizing the strategies outlined can significantly minimize your tax burden,

preserving your wealth and enhancing your financial future.

If you're considering selling your California property or need guidance with real estate planning,

consult with a Certified Real Estate Planner to explore personalized strategies for your unique

situation.