Understanding California Capital Gains Tax:
Rules & Exemptions
Whether you’re selling property, cashing in on investments, or navigating a complex portfolio, understanding how capital gains are taxed in California is important. Unlike many states, California applies unique rules that can significantly impact your overall tax burden. In this article, we’ll break down what capital gains tax is, how California’s approach differs from federal law, and what exemptions and strategies can help you reduce what you owe.
With smart planning and a solid grasp of the rules, individuals and business owners can make more informed financial decisions.
What Is Capital Gains Tax?
Basic Definition and Purpose
Capital gains tax is the tax applied to the profit made when you sell an asset for more than you paid for it. Common examples include the sale of stocks, bonds, real estate, or a business. The tax is assessed on the gain—that is, the difference between your purchase price (basis) and the selling price.
There are two main categories:
- Short-term capital gains: Profits from assets held for one year or less.
- Long-term capital gains: Profits from assets held for more than one year.
Short-Term vs. Long-Term Capital Gains
At the federal level, long-term capital gains typically receive favorable tax treatment, with lower rates compared to short-term gains, which are taxed as ordinary income. This distinction rewards investors who hold assets for longer periods.
However, California takes a different approach—which we’ll explore next.
California’s Capital Gains Tax Rules
How Capital Gains Are Taxed in California
California treats all capital gains as ordinary income—regardless of whether they’re short-term or long-term. This means there’s no preferential rate for long-term investments as there is at the federal level.
If you earn a capital gain in California, it gets added to your regular income and is taxed according to the state’s progressive income tax brackets.
Tax Rates for Capital Gains in California
California’s income tax rates range from 1% to 13.3%1, depending on your income level. Here’s a simplified breakdown:
- $0 – $70,606 (single filers): taxed at 1% to 8%
- $70,607– $721,314: taxed at 9.3% to 11.3%
- Above $1 million: taxed at the top rate of 13.3%
So, for example:
- If you’re a single filer making $100,000 annually and sell a stock for a $20,000 gain, that gain will be taxed at your marginal income tax rate—likely around 9.3% or higher.
Exemptions and Special Cases
Exemption for Primary Residence
One of the most common exemptions applies to the sale of a primary residence. If you’ve owned and lived in the home for at least two of the last five years, you may exclude up to:
- $250,000 of gain for single filers2
- $500,000 for married couples filing jointly2
This federal exemption also applies when calculating California income taxes, but certain nuances may apply, especially for mixed-use properties or partial years of occupancy.
1031 Exchange for Real Estate
A 1031 exchange allows you to defer capital gains taxes when selling an investment property—as long as you reinvest the proceeds into a similar property. Key requirements include:
- The new property must be identified within 45 days.
- The transaction must be completed within 180 days.
- The exchange must be between “like-kind” properties.
Used correctly, a 1031 exchange can be a powerful tool for real estate investors seeking to grow their portfolios without triggering immediate tax consequences.
Other Exemptions or Deductions
Certain gains may qualify for additional benefits, such as:
- Qualified Small Business Stock (QSBS): Some small business stock may qualify for partial or full exclusion of gains under federal rules (Section 1202), which California generally does not conform to.
- Retirement Accounts: Gains within IRAs, 401(k)s, and similar tax-advantaged accounts are not taxed until withdrawal.
Key Differences Between Federal and California Capital Gains Tax
Federal vs. State Taxation
At the federal level, long-term capital gains are taxed at 0%, 15%, or 20%, depending on your income. California, on the other hand, does not offer a lower rate for long-term gains—they are taxed just like wages or interest income.
Impact of Federal Tax Reforms
Federal laws such as the Tax Cuts and Jobs Act (TCJA) have changed how gains are taxed at the national level—for example, by increasing the standard deduction and modifying income thresholds. However, California did not adopt many of these changes, maintaining its own separate tax rules and brackets.
Strategies to Minimize California Capital Gains Tax
Tax-Loss Harvesting
Tax-loss harvesting involves selling investments that have lost value to offset gains from other investments. This can help reduce your taxable capital gains. For example, if you made $10,000 in gains but realized $4,000 in losses, you would only be taxed on $6,000 of net gains.
Holding Investments Longer
Although California doesn’t tax long-term gains at a lower rate, holding investments longer can still be beneficial—especially if you expect to be in a lower income tax bracket in the future. Timing a sale to coincide with retirement or a lower-income year may reduce your overall tax liability.
Investing in Tax-Advantaged Accounts
Using accounts like IRAs, Roth IRAs, or 401(k)s can defer or even eliminate capital gains taxes:
- Traditional accounts defer taxes until withdrawal.
- Roth accounts grow tax-free, and qualified withdrawals are tax-free—even on gains.
How California’s Capital Gains Tax Affects Your Financial Planning
Planning for Property Sales
Selling a home or investment property in California? Planning ahead is essential. Understand your cost basis, potential exemptions, and the timing of the sale. Strategic decisions—like completing a 1031 exchange or meeting the primary residence test—can make a significant difference in your tax outcome.
Considerations for High-Income Earners
High earners face the highest marginal tax rates in California, meaning capital gains can have a larger impact. Working with a financial advisor can help you explore charitable giving, installment sales, or other techniques to reduce your taxable income and manage timing effectively.
Stay Informed and Plan Ahead with Knowledgeable Guidance
Navigating California’s capital gains tax system takes planning, insight, and awareness of the latest rules and exemptions. With the right strategy, you can reduce your tax liability and preserve more of your gains—whether you’re selling real estate, a business, or an investment portfolio.
Need help navigating California’s capital gains tax rules? Contact Insight today to get expert advice and start planning your financial future with confidence.
Reviewed by,
Brian Stormont, CFP®
Brian Stormont is a comprehensive, fee-only financial advisor with Insight Wealth Strategies who began his career in the financial industry in 2000. His expertise encompasses retirement planning, investment planning, estate planning, and high-level strategies to help business owners and individuals minimize their income taxes.
Sources:
- https://taxfoundation.org/data/all/state/state-income-tax-rates/
- https://www.irs.gov/newsroom/tax-considerations-when-selling-a-home
Insight Wealth Strategies, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Insight Wealth Strategies, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Insight Wealth Strategies, LLC unless a client service agreement is in place.
Insight Wealth Strategies, LLC (IWS) and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
