Capital Gains on Selling a House in 2025: What California Homeowners Should Know
If you are a California homeowner planning to sell, one of the biggest concerns is whether you will owe capital gains tax when you sell your home. The idea of capital gains on selling a house can sound scary, especially if your home has appreciated substantially over time. But the rules under the tax code are surprisingly favorable in many cases. This post will break down how capital gains tax works, when you might owe capital gains tax, how to calculate capital gains tax, what capital gains tax exclusion you might qualify for, and strategies to reduce capital gains tax or even avoid capital gains tax entirely.
When you understand this clearly, you can make confident decisions when you sell your house, avoid unexpected tax liability, and maximize what you take home.
What Is Capital Gains on Selling a House?
When you sell your primary residence or any real property, the gain from the sale is the difference between your selling price minus your adjusted basis and selling costs or selling expenses such as real estate agent commissions and settlement fees. That gain is effectively your net profit on the transaction. If that gain is positive, it is a capital gain subject to gains tax on real property.
But not every capital gain is taxed. In fact, under Internal Revenue Service rules, much of it may be excluded or taxed at favorable rates depending on your circumstances.
Capital Asset, Cost Basis, and Adjusted Basis
Your home is considered a capital asset for tax purposes. The starting point to understanding your gain is to know your cost basis (often the original purchase price) and then compute adjustments. Your adjusted basis generally equals your original purchase price plus the cost of home improvements and other qualified additions, minus certain deductions (such as any depreciation deductions if used as rental property generating rental income). Properly accounting for improvements can help reduce the taxable gain when you sell.
When Is the Gain Taxable?
If your gain is entirely excluded (more on that soon), you won’t pay capital gains tax or pay taxes on that portion. But if the gain exceeds your exclusion amount or you don’t qualify for full exclusion, the excess gain is taxable. How much tax you owe depends on whether the gain is short term or long term, your taxable income, and whether you have depreciation recapture (especially if the property was used as rental property).
The Capital Gains Tax Exclusion for Homeowners
One of the most powerful provisions available to homeowners is the capital gains tax exclusion under IRS rules (Section 121 rules). This means many homeowners will not pay capital gains tax at all.
How the Exclusion Works
If you meet certain requirements, you can exclude up to $250,000 of gain if you are single or married filing separately, or up to $500,000 if married filing jointly (or married couple filing jointly). This is often called the capital gains exclusion or home sale exclusion. The idea is, you can shelter that amount of gain from being taxed.
To qualify, you must satisfy two tests, commonly called the ownership and use tests:
- Ownership test: You must have owned the home for at least 2 out of the last 5 years before the sale of your home.
- Use test: You must have used the home as your principal residence for at least 2 out of the last 5 years.
These 2 years do not need to be continuous, and they don’t have to be the same 2 years for both tests.
If you satisfy both, and haven’t used the exclusion on another home sale in the prior 2 years, you can exclude up to that limit. For married couples, only one spouse needs to meet the ownership test, but both spouses must meet the use test to claim the full exclusion amount.
Limits and Restrictions
You can only use the exclusion once every two years. Also, the exclusion does not apply to the portion of gain attributable to depreciation claimed (for periods you used the property as a rental), since depreciation recapture must be recognized even if you qualify for the exclusion.
If either of the tests is not met, you might still qualify for a partial exclusion under certain circumstances (such as health, job change, unforeseen events).
When and How Much You Might Owe Capital Gains Tax
If your gain is not fully excluded, you will need to pay tax on the remaining amount. Here’s how that works.
Long Term vs. Short Term Capital Gains
If you have owned the home less than one year (less than a year), then the gain is considered short term capital gains and is taxed at your ordinary income rate (your standard tax bracket). That means it is taxed like ordinary income.
If owned for more than one year, it is long term capital gains, which enjoys more favorable tax rates. These are often 0%, 15%, or 20% depending on your taxable income.
Capital Gains Tax Rates in 2025
For 2025, here are general thresholds (these apply to net capital gains after exclusion):
- For a single filer, if your taxable income (including the gain) is up to about $48,350, you could be in the 0% bracket for long term gains.
- Between about $48,351 and $533,400, long term gains are taxed at 15%
- Above $533,400, long term gains are taxed at 20%
But note, these brackets are for the gain portion. Your other ordinary income is taxed separately at ordinary rates.
Net Investment Income Tax and Additional Taxes
If your adjusted gross income is high, you may also be subject to the 3.8% Net Investment Income Tax (NIIT) on top of capital gains tax. This can apply to capital gains on selling a house when it is not fully excluded.
In California, there is no separate capital gains rate, gains are taxed as ordinary income under state income tax. That means state tax could add significantly to your tax liability.
Depreciation Recapture on Rental Use
If part of the property was used as rental property or business use, and you claimed depreciation deductions, you must recapture depreciation. That means you pay tax on the amount of depreciation taken, taxed as ordinary income or at a special rate (often up to 25%).
Even if part of your property qualifies for exclusion (because it was your primary residence), the portion attributable to depreciation cannot be excluded.
Expatriate Tax Considerations
Certain taxpayers subject to expatriate tax or those in the foreign service, government housing, or intelligence community may have special rules suspending the 5-year test period for ownership and use, allowing for an extended timeframe to qualify for the exclusion.
