Let’s face it—nobody jumps out of bed in the morning excited about paying taxes. But if you’re a Californian with investments, real estate, or a thriving business, understanding capital gains tax is crucial to keep as much of your hard-earned cash as possible. And in California, where the tax bills burn as hot as the sun, capital gains tax can be a bit unforgiving. But don’t panic. Today, we’ll explain how much you can expect to pay on capital gains in California, why it differs from the federal system, and how to soften the blow. Ready? Let’s roll!
What Are Capital Gains?
First things first: what are capital gains? In a nutshell, capital gains are the profits you make when you sell an asset for more than you originally paid for it. These assets can include stocks, bonds, real estate, or even a business.
The IRS and most states, including California, tax these gains. Capital gains are generally split into two categories:
- Short-term Capital Gains: Gains from assets you hold for less than a year.
- Long-term Capital Gains: Gains from assets you hold for over a year.
Most states (and the federal government) charge long-term gains at a lower tax rate to encourage long-term investments. But, spoiler alert: California does not.
How California Taxes Capital Gains
While the federal government taxes long-term capital gains at reduced rates of 0%, 15%, or 20%, depending on your income, California’s tax system takes a different approach. Here’s where the Golden State gets a little less golden for taxpayers.
Most states offer some relief on long-term gains, but California is an outlier here. There’s no preferential treatment for long-term capital gains (it gets the same tax treatment as ordinary income). This lack of distinction means that even if you’ve held an asset for years (like a house or a stock portfolio), you’ll still face high taxes when you sell.
In contrast, at the federal level, long-term capital gains are taxed at reduced rates to encourage long-term investment. So, while the IRS gives you a break, California says, “Not so fast!”
So, whether you held onto your asset for a month or a decade, California doesn’t care—you’re paying the same rate. And with the state’s progressive income tax system, those rates range from 1% to 13.3%. The highest rate includes an additional 1% Mental Health Services Tax for individuals earning over $1 million, meaning the effective top rate for capital gains is 13.3%.
California’s Progressive Income Tax Brackets
Here’s a quick breakdown of the 2024 California income tax brackets that apply to your capital gains:
- 1% tax rate for $0 – $8,932 income
- 2% tax rate for $8,933 – $21,175 income
- 4% tax rate for $21,176 – $33,421 income
- 6% tax rate for $33,422 – $46,394 income
- 8% tax rate for $46,395 – $58,634 income
- 9.3% tax rate for $58,635 – $299,508 income
- 10.3% tax rate for $299,509 – $359,407 income
- 11.3% tax rate for $359,408 – $599,012 income
- 12.3% tax rate for $599,013+ income
- 13.3% tax rate for income over $1 million (including the extra 1% Mental Health Services Tax)
Let’s put the above into perspective: if you’re a high earner selling a property or business, your capital gains could incur the maximum 13.3% rate. Ouch!
Impact on High-Income Earners
The more you earn, the more you’re taxed; capital gains are no exception in California. For those in the higher income brackets, especially individuals earning over $1 million, the combined federal and state capital gains tax can take a significant chunk out of your profits.
For example, if you sell a California property for a large profit, the federal government may tax your long-term capital gains at 20%, and California will slap on up to 13.3%. That’s a combined rate of up to 33.3%!
High earners need to be particularly cautious when planning sales of significant assets because their tax liabilities can quickly add up.
Strategies to Reduce Capital Gains Tax in California
The good news? You’re not entirely powerless. The following strategies can help minimize your capital gains tax burden in California:
Tax-Loss Harvesting: Offset your capital gains by selling underperforming investments at a loss, as this can help you reduce the amount of gains subject to taxes.
Invest in Opportunity Zones: Reinvesting capital gains into Qualified Opportunity Funds (QOFs) allows you to defer taxes and potentially reduce the taxable amount after holding the investment for a specified time.
Charitable Donations: You can donate appreciated assets to charity to bypass capital gains taxes while claiming a charitable deduction on your taxes.
Installment Sales: Spread the sale of a substantial asset over several years using installment payments. This strategy can help keep your taxable income (and the associated tax rate) lower each year.
Summarizing The Key Differences: Federal vs. California Capital Gains Tax
- Federal: Long-term capital gains attract 0%, 15%, or 20% tax rates, depending on your income.
- California: Capital gains—both long-term and short-term—are taxed as ordinary income, with rates ranging from 1% to 13.3%.
Parting Note
Paying capital gains tax in California may feel like getting the short end of the stick, especially when you compare it to federal tax rates. With no preferential treatment for long-term gains and tax rates as high as 13.3%, planning and taking advantage of strategies to reduce your tax burden is crucial.
If you’re a high-income earner or planning a big sale, consider working with a tax professional who can guide you through the nuances of California’s capital gains tax and help you make the most of your profits. After all, the goal is to keep more of what you’ve earned.
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That’s where Tax Goddess comes in. We are specialists in helping business owners, entrepreneurs, and investors pay lower tax rates legally. So far, we have helped our clients claim over $1.68 BILLION in tax savings! If you are serious about saving millions of dollars in tax savings without pissing Uncle Sam off, let’s talk.
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