Homeowners must pay taxes on capital gains, or profits, they make from a home sale. They can get exemptions from that sale. California generally conforms to federal rules regarding exemptions, but the state also has its own rules. The IRS and the California Franchise Tax Board (FTB) have some different capital gains requirements when selling a house. Both allow homeowners to exclude a specific amount of money on the sale of their homes, provided the property owner has only one main home at a time when requesting the exemption. It may be a house, condominium, cooperative apartment, houseboat, mobile home or trailer.
What Are Capital Gains?
When a homeowner sells his home for more than he paid for it, a capital gain occurs. It’s the profit that is the difference between the selling price and the original purchase price, less some items like depreciation and capital improvements. When the homeowner realizes this profit, the government wants some of this income, known as the capital gains tax. There are two types of gains: realized and unrealized. A realized gain comes from selling an asset at a price higher than the original purchase price. When that asset sells at a loss, it is a realized gain.
A homeowner must calculate and withhold capital gains taxes from the sale or transfer of a property during the tax year in which she sells it. The buyer of the home can request that the real estate escrow professional who helped him with the purchase calculate the capital gains tax and withhold that amount for him. Some circumstances do not require this, including when the total sale price of a property is $100,000 or less, or when a home sells in foreclosure.
Calculating Capital Gains in a Home Sale
A seller can figure out capital gains taxes reasonably quickly by first taking the selling price or gross amount paid by the new homebuyer and subtracting expenses incurred in the sale process, including advertising, legal fees and title transfer fees. Next, the seller must figure out his cost basis, or purchase price, of the property, provided he was the purchaser. If he was not, he can follow California Revenue and Tax Code instructions on calculating the total using Form 593-C and deduct the basis from that result. Then, he should subtract any loan points he paid as a seller.
Next, he must calculate the depreciation on his property’s value during the years he owned it and note if he took that depreciation or not. In calculating depreciation, there are several factors to consider, including the type of property it is and the homeowner’s specific circumstances. After deducting the depreciation, he then must subtract any improvements he made to the property to learn the estimated gain on its sale. If the number is negative, he’s lost money on the sale and so does not have to pay any capital gain taxes.
Full Exemptions to Capital Gains Tax
When selling a home, the capital gains real estate tax exemption allows a full exemption of $250,000 per taxpayer per tax year. It equals $250,000 for a single person or a married person filing separately. For purposes of California income tax, references to a married couple also refer to a California registered domestic partner or partnership, unless otherwise specified. When a couple files jointly, the exemption amount is $500,000. The home sale must have occurred after May 6, 1997 — sales before that date are generally not eligible.
Additionally, the property owner seeking the exemption must have owned and lived in the home for at least two of the last five years before selling it and he can use this exclusion every two years. As an example, if he has a home for a year and a half and attempts to sell it at the end of the second year, the sale has met these criteria. If, however, he rented the home out for four of the five years, he could not meet this exemption. If a homeowner can’t meet the full capital gains tax exemption, there are partial exemptions he may be able to achieve.
Partial Exemptions to Capital Gains Taxes
It is a common occurrence that a homeowner looking to get an exemption won’t meet the criteria for a full one. She could, however, meet a partial exemption to get some tax relief. Some possible partial reasons are:
- A change of employment: The homeowner took a job or was transferred to a work location at least 50 miles further away from her residence than her old work location or she begins a new job at least 50 miles from home. The same applies to her spouse, another co-owner of the home, or anyone else for whom it is a residence.
- A move for health reasons: The homeowner must move to facilitate diagnosis, cure, mitigate or treat a disease, illness or injury to herself or her family member or obtain or provide medical care for that person. This also applies if a doctor recommends a change in residence for the homeowner or her spouse, a co-owner of the home, or anyone else for whom the home is a residence.
- Unforeseen events: These include the destruction or condemnation of a home because of a natural or man-made disaster or an act of terrorism. Death of the homeowner, her spouse, or anyone else for whom the home was a residence; divorce or legal separation; multiple births of more than two children; and unemployment can also apply.
- Additional circumstances: If the homeowner’s situation doesn’t match any of these, she can qualify if she can demonstrate her situation relates to one of them. If she can prove that it arose during the time she owned and lived in the property; sold the home not long after; couldn’t have anticipated what was going to happen; experienced great financial difficulty in maintaining it; or it became less suitable for her and her family to live in, then a partial exemption may apply.
To calculate the exemption, the homeowner must count the number of months she lived in the home if the minimum two years were not possible. For example, if she was in residence for one year, she would get 50 percent of $250,000, or $125,000. If she is a senior who must move to a nursing home, the ownership duration lowers to only one year out of the past five.
How to Report a Home Sale Tax Federally
If a homeowner has a gain in which an exemption does not apply, the IRS considers it taxable. He must report it to the agency on a Schedule D Form 1040 or Form 1040-SR. However, the homeowner does not have to report the sale of his main home on his tax return if:
- He has a gain and does not qualify to exclude all of it.
- He has a gain and chooses not to exclude it.
- He has a loss and files a Form 1099-S.
If he has more than one property, he can exclude gain only from the sale of his main residence. If he sells another property, he must pay tax on the gain from that sale.
If a homeowner has two properties and lives in both homes, his main property would be the one he lives in most of the time. As an example, he could primarily live in a home in a city and also own a beach house that he uses during the summer. In another example, he could own one house, but live in another that he rents. The rental property would, therefore, be his primary home. A homeowner can also exclude gain from the sale of a home that he has used for business or as a rental property, but he first must meet the two main criteria of ownership and use tests.
How to Report Home Sale Tax in California
As of January 1, 2015, California law has followed the Internal Revenue Code, but there are distinct differences between federal and state tax rules regarding gains from a home — the state does not always conform to federal tax law changes. A homeowner who needs to report sales tax on her home can research the differences in federal and state laws on the California Franchise Tax Board website at ftb.ca.gov. She can also find additional information in these state publications:
- FTB Pub. 1001, Supplemental Guidelines to California Adjustments.
- California Schedule CA (540) instructions.
- California Adjustments - Residents, or Schedule CA (540NR).
- California Adjustments - Nonresidents or Part-Year Residents.
- Business entity tax booklets.
These instructions aid taxpayers in preparing their California income tax returns. Still, it is not possible to include all requirements of the California Revenue and Taxation Code in these instructions, so a homeowner should not consider them the final authority. For any questions on how to file capital gains tax in California, homeowners should have a certified tax preparer or tax attorney look over their paperwork before submitting it to the IRS or the state Franchise Tax Board. If there is a mistake, she should file a tax amendment return as soon as possible to avoid any allegations of inappropriate tax submittals or other legal issues.
- California Franchise Tax Board: Capital Gains and Losses
- IRS: Publication 523 (2019), Selling Your Home
- California Franchise Tax Board: California Capital Gain or Loss Adjustment
- California Franchise Tax Board: Income From the Sale of Your Home
- Movato: California Capital Gains Tax: Is It Possible to Avoid When Selling Your Home?
- Nolo: Avoiding Capital Gains Tax When Selling Your Home: Read the Fine Print
- Investopedia: What Is a Realized Gain?