When you’re a California landlord selling rental property, capital gains taxes are one of the many costs that might keep you up at night. Of course, you’ll also have to get the property ready for sale—even minor repairs can add up to a pretty penny. Plus, you can expect to pay a real estate agent and California commission rates are sky high compared to other states. The expenses of selling just keep adding up. Isn’t there a better way, one that will leave a little more cash in your pocket? If you understand how taxes on the sale of a rental property in California are calculated, you can make a more informed decision about how to go about selling it—and keeping costs down.
What Are the Taxes on the Sale of Rental Property in California?
You aren’t the only one who gets uneasy about the capital gains taxes on a California rental property—these taxes are some of the high highest in the world and complex to understand. It takes a few steps to calculate the capital gains tax applied to rental property sale and you will probably have your accountant figure your actual tax. Conceptually, however, it is not too hard to grasp.
Broadly speaking, a capital gain is determined by subtracting the purchase price of the property from the sale price. Unless your property has declined in value, there will always be capital gain.
Once you know how much of a capital gain you’ll be taxed on, you can figure out how much tax you may owe. The way that taxes on capital gains are figured differs according to how long you’ve owned the property.
- Short-term capital gains on a property you have owned for less than a year are taxed like ordinary income at both the federal and state levels.
- If you own the investment property for more than a year, the long-term federal capital gains tax can be 0%, 15%, or 20%, depending on your income bracket. On top of that, California will charge another 1% to 13.3% when you sell. So, if you’re a millionaire, your total capital gains taxes will be 33.3%.
The math gets more complex when we factor in depreciation and depreciation recapture. Briefly, the idea behind depreciation is that a rental property loses value over time, so you should pay less taxes on it. For residential property, the federal depreciation period is 27.5 years, which means that you deduct 1/27.5 of the purchase price of the building only—not the land—every year. For California taxes, the depreciation period for residential rental property is 45 years, so that requires a separate set of calculations.
Let’s say, for instance, that you bought a rental property for $500,000. You will, of course, want to use the appraiser’s numbers when figuring out how much of that cost is for the land and how much for the building. For the sake of simplicity, we’ll use the old 80/20 rule of thumb that many accountants cut their professional teeth on. Under this guideline, 80% of the purchase price, or $400,000 is depreciable.
$400,000 / 27.5 = $14,545 Annual Federal Depreciation Deduction
$400,000 / 45 = $8,889 Annual California Depreciation Deduction
Have you gained new respect for your accountant? Good. There’s only a little more to the story now. While you have been receiving rental income from the property and declaring it on your income tax, along with a depreciation deduction, in real life, the property most likely hasn’t been depreciating. It has gained in value and now that you’re selling it, the government, predictably, would like part of those depreciation deductions back. That’s called recapture.
The total amount of depreciation you deducted over the years is added up and made subject to a 25% flat tax by the federal government and a 9.3% tax by the state of California. Those could also be sizable payments, especially if you have owned the property for a long time.
And there you have it, all four taxes you pay on the sale of a rental property in California: federal capital gain and depreciation recapture as well as California capital gain and depreciation recapture.
Adding Up All the Costs of Selling Your Rental Property
Taxes are not the only expenses you will have to deal with when you sell your rental property. Depending on the state of the property, it could take a significant sum, as well as time and effort, to get it ready for the market. Then the real estate agent will want a cut of the sale price, and there are always incidentals that you don’t foresee. So let’s keep calculating.
You have to make the sale before you see any of that capital gain. There are several other major expenses before you get there though.
A property has to be in good repair to receive the best price on the real estate market. And rental properties can get pretty beat up. Many property improvements won’t necessarily give you an increase in return on your investment but they may be important for making the sale happen.
But be ready for some big price tags. New central air conditioning will cost around $5,000, and a new heating system will set you back about $4,000—and those are low-end estimates. The cost of replacing a roof averages close to $7,000. Kitchen remodels start at around $5,000 and rise steeply in price from there. But don’t skimp on these repairs if you want to get the property sold.
Real estate agent commissions
Sure, you can go with a discount or flat-fee broker but you increase your risk of not getting the property sold in the timeframe that you are hoping. Commissions for a full-service broker, however, can reach as high as 5% to 6%. Keep in mind, though, that even with the best agent, selling your house can be a slow process and no sale is ever guaranteed until everyone has signed on the dotted line.
Staging the property
Setting the stage to woo potential buyers can make or break your ability to get it sold. You will undoubtedly have to get a few gallons of paint on the walls and some fresh plants for the flowerbeds. It can be challenging to get contractors in to do the work, however, if you have tenants still in the building. If you really want to get the rental property sold, you might consider offering them ‘cash-for-keys’ to get them out of the way first.
Utilities have to be paid until the house sells and there is maintenance to think of too. Even if you mow the lawn and do the dusting yourself, your time is worth money. And don’t forget to keep up on the taxes and insurance. You’ll be hard pressed to find an eager buyer for a rental property that has liens on it.
Selling your house in California can require a lot of money up front. Potentially, you could have to lay out tens of thousands of dollars on repairs, commissions, staging, and holding costs before you see any sale money at all. Thankfully, there is a way to sell your rental property quickly and save on some of the costs, too.
A Cheaper, More Reliable Way to Sell Your Rental Property
While we can’t save you from Uncle Sam, Osborne Homes can buy your rental property fast, often in as little as a week. As a locally-trusted real estate investing company, we buy property in any condition—even if you are selling with tenants in residence. There’s no need to spend big money on fixing everything up and then shelling out thousands more to a real estate agent only to wait months for a viable offer to come in. We’ll come out and take a look at your property then we’ll make you a fair offer. When you balance our offer against the money you didn’t spend on repairs and an agent, paying the capital gains taxes won’t feel so bad.