Selling or buying a property in the country’s most competitive real estate market is no easy feat, but when you start taking taxes into account, the process of selling your California home can quickly become an incredibly expensive feat!
Now, no matter how steep tax rates might be at the moment, you should keep in mind that there’s no way you can cut corners or avoid paying taxes when selling a property.
Being well-read and updated on the ins and outs of California’s tax law is a fundamental first step when selling a home, and your real estate agent or real estate lawyer will usually be the first person to talk you through all the legal aspects of the transaction before you list your property.
But what if you decide to sell your home without a local real estate broker to oversee the process?
How can you make sure you’re not only paying the tax bill you owe but also taking advantage of the system in a way that will dramatically reduce your tax bill, 100% legally?
Here’s all you need to know about capital gains taxes and property taxes in California before you go ahead with the sale of your home, including a few tips on how to make the most out of capital gains exemption!
The Capital Gains Tax in California
Capital gains are defined as the total profit derived from the sale of a capital asset, such as a business, land, stocks, and (in some cases) real estate. In terms of how to report them, capital gains are usually registered as taxable income and treated as such, unless they are considered long-term capital gains.
Long-term capital gains are profits derived from the sale of an investment that has been owned for over 12 months at the time of the transaction. They are given a more favorable treatment compared to short-term capital gains, which instead are assets and investments the seller has owned for less than a year.
In this case, favorable treatment means much lower tax rates: Sellers will usually owe either 18% or 28% depending on their income and marital status, with a tax exemption (zero rate) available for a few selected taxpayer categories.
However, the difference between short-term and long-term gains does not apply to tax purposes. As Ben Geiern explains in his article on SmartAssets, the state taxes all capital gains as regular income, using the same rates and brackets. This means that both short-term and long-term capital gains are subject to California’s progressive income tax rates, which range from 1% to 13.3%.
How to Figure Out Your Capital Gain?
Calculating your capital gain or loss is crucial for understanding your capital gains tax obligations. To start, you’ll need comprehensive records, including the purchase price of the asset, the sale price, and any associated costs such as commissions and fees. According to H&R Block, the process involves several key steps:
- Determine Your Basis: This is essentially the original cost of the asset, which includes the purchase price plus any commissions, fees, or improvements made to the asset. It’s important to note that reinvested dividends and other factors can also increase your basis.
- Calculate the Realized Amount: This is the amount you sold the asset for, minus any commissions or fees from the sale.
- Subtract the Basis from the Realized Amount: This calculation will give you either a capital gain or loss. If the sale price is higher than the purchase price and associated costs, you have a capital gain. If it’s lower, you have a capital loss.
- Understand the Tax Rate: The article emphasizes that the tax rate on your capital gain depends on how long you’ve held the asset. Short-term capital gains (for assets held for one year or less) are taxed at ordinary income rates, while long-term gains (for assets held for more than one year) are taxed at reduced rates, which can be 0%, 15%, or 20%, depending on your income.
For homeowners calculating gains on property sales, it’s crucial to account for the original purchase price, commissions paid at purchase, and the cost of any home improvements. After tallying these costs, subtract them from the current sale price.
Additionally, you can subtract any applicable exemptions (like the $500,000 exclusion for married couples filing jointly on the sale of a home they’ve used as a primary residence for at least two of the last five years) to determine the taxable gain.
Property Taxes
Once you’ve taken care of capital gains taxes, you’ll also have to think about any property taxes paid in advance as well as property taxes due in escrow. This is a crucial aspect to consider during the negotiation of closing costs with the buyer. It’s essential to clearly negotiate who will pay what and when with the buyer and lender well before the closing date.
Typically, the seller is responsible for paying prorated property taxes for the period they have lived in the property since the start of the new tax year. Conversely, the buyer would cover the prorated amount for the remainder of the year. If you’ve already paid property taxes in advance, it’s possible to negotiate with the buyer to have the prorated amount credited back to you, simplifying the process of managing property taxes.
In California, as mentioned by Tax-Rates.org, the median property tax is $2,839.00 per year for a home valued at the median price of $384,200.00, which translates to an average property tax rate of 0.74% of a property’s assessed fair market value. It’s important to note that property tax rates vary significantly across different counties in California, affecting the overall financial outcome of selling your house.
For instance, Marin County has the highest property tax, averaging $5,500.00 annually, while Modoc County has the lowest, with an average tax of $953.00 per year. This variability underscores the importance of understanding local tax rates and negotiating property tax responsibilities accordingly during the sale process.
Moreover, about 25% of homes in America are unfairly overassessed, leading to homeowners paying an average of $1,346 too much in property taxes every year. If you suspect your property has been overassessed, it’s advisable to seek a reassessment or appeal, which could potentially adjust the prorated taxes due or credited at closing.
Transfer Tax
Transfer tax doesn’t get as much exposure as capital gains taxes or property tax when it comes to the costs of selling a property, mostly because not all states and cities charge it. This tax is usually another part of the closing costs shared by the seller and buyer, and it’s based on the value of the property and its classification. In most cases, the seller is the party liable for paying transfer tax, but both parties can agree if the seller is eligible for transfer tax exemption or is unable to pay.
In California, transfer taxes can indeed be quite expensive, and as Max Efrein from HomeLight points out, you’ll likely end up paying taxes to three different bodies (state, county, and city) as well as a smaller HOA transfer fee. The documentary transfer tax in California varies depending on the location within the state, with general law counties and cities permitted to charge 55 cents per $500 of property value or the amount paid ($1.10 per $1,000).
This rate can only be increased by charter counties or cities, that have adopted a charter and therefore have supreme authority over municipal affairs. Among California’s 482 cities, 121 have charters.
For example, the documentary transfer tax on a $500,000 home in some of California’s largest cities would look like this:
- San Diego: 55 cents per $500, resulting in a $550 transfer tax.
- Sacramento: $1.375 per $500, leading to a $1,375 transfer tax.
- San Francisco: $3.40 per $500, amounting to a $3,400 transfer tax.
- Los Angeles: $2.25 per $500, equating to a $2,250 transfer tax.
Is It True That You Can Sell Your Home And Not Pay Capital Gains Tax?
As we said at the beginning of this article, there’s no cutting corners when it comes to paying taxes, especially in a state like California where closing costs can end up being as high as 8% or even 10% of the sale price.
But that doesn’t mean that you can’t use local laws in your favor and take advantage of exemptions if you’re eligible!
Capital gains tax will often end up being the most expensive fee you’ll have to pay as a seller. While there’s no way around paying capital gains as taxable income, if you have owned the property for less than a year, you’ll find that in many cases sellers can get out of paying capital gains tax.
According to Investor Times, there are several strategies and exemptions available that can help you minimize or even avoid capital gains tax altogether in California. Here are some key methods:
- Primary Residence Exclusion: If you have lived in your home for at least two out of the last five years, you may be eligible for an exclusion of up to $500,000 in capital gains ($250,000 for single filers) when you sell your home.
- 1031 Exchange: This allows you to defer capital gains tax on the sale of an investment property by reinvesting the proceeds into a like-kind property.
- Investing in Opportunity Zones: These are designated low-income areas where investments can receive significant tax benefits, allowing you to defer and potentially reduce capital gains tax.
- Charitable Donations: Donating appreciated assets to a qualified charity can eliminate capital gains tax on the appreciation.
- Tax-Loss Harvesting: This involves selling investments that have declined in value to offset capital gains, reducing your overall tax liability.
Conclusion
Buying and selling a home in California means dealing with taxes. Yet, there are ways to lower what you owe. Explore exemptions for capital gains and ask a tax expert for help. This can lead to real savings, making your sale more rewarding.
I’m Tanner Murphy, a retired real estate agent from California, now writing for propertyescape.net. I simplify California’s complex real estate laws for readers, making it easier to understand and navigate the market.
