California’s 13.3% Rate: No Reduced Rate for Long-Term Gains

The federal tax code gives you a discount for patience. Hold a stock for more than a year and the maximum federal rate drops from 37% to 20% (plus the 3.8% NIIT). California doesn’t follow that logic. The Franchise Tax Board treats capital gains as ordinary income, period.

That means your $800,000 gain from selling a West Hollywood investment property gets stacked on top of your salary, freelance income, and everything else. If your total taxable income exceeds $1 million, the entire gain is taxed at 13.3%. The 1% Mental Health Services Tax is already baked into that number.

Compare that with a state like Florida (0%), Texas (0%), or even New York (which also taxes gains as ordinary income but tops out at 10.9% state-level). California’s rate is the steepest any state charges on investment gains.

What LA Homeowners Need to Know About the Primary Residence Exclusion

The federal government lets you exclude up to $250,000 of gain ($500,000 for married couples) when you sell your primary residence, as long as you’ve lived there for two of the past five years. California conforms to this exclusion.

For Los Angeles, where the median home price is well above $900,000 and properties purchased a decade ago have doubled or tripled, that $500,000 exclusion doesn’t always cover the full gain. A couple who bought in Mar Vista for $650,000 in 2014 and sells for $1.8 million has a $1.15 million gain. After the $500,000 exclusion, they still owe California tax on $650,000. At the 13.3% rate, that’s over $86,000 in state tax alone, on top of federal capital gains tax.

No one thinks about this until they’re at the closing table. If you’re sitting on a large gain in your LA home, planning the sale a year or two in advance can make a meaningful difference.

Startup Founders and QSBS Exclusion

Section 1202 of the Internal Revenue Code allows founders and early investors to exclude up to $10 million (or 10x their basis) of gain from the sale of Qualified Small Business Stock held for at least five years. The federal exclusion can be worth millions. California doesn’t conform.

California excluded QSBS gains partially in the past but currently treats the full gain as taxable income. A founder in Santa Monica who sells their startup for $15 million and qualifies for the federal QSBS exclusion might pay zero federal capital gains tax but still owe California $2 million. That’s the kind of gap that drives founders to establish residency in Nevada or Wyoming before a sale.

If you’re thinking about this, start early. California’s residency rules are strict, and the FTB has a reputation for auditing departing high-income residents. Moving to Austin or Miami six months before a sale and expecting California to look the other way is not a plan. It’s a gamble.

Rental Property and Depreciation Recapture

LA is a landlord city. Plenty of residents own rental properties in the Valley, Koreatown, East LA, or the Westside. When you sell a rental, you owe tax on the gain plus depreciation recapture. At the federal level, depreciation recapture is taxed at 25%. California taxes it as ordinary income, same as any other gain.

A 1031 exchange lets you defer both federal and California capital gains tax by reinvesting the proceeds into a like-kind property. California conforms to federal Section 1031 rules, but there’s a catch: if you exchange into a property outside California and later sell, California may still claim tax on the original deferred gain. You’ll file Form 3840 to track the exchange, and the FTB follows up.

Strategies to Reduce California Capital Gains Tax

Tax-loss harvesting works the same way at the state level as it does federally. Selling losing investments to offset gains reduces your California taxable income dollar for dollar. The $3,000 annual cap on net losses applies at both levels.

Charitable remainder trusts (CRTs) let you sell appreciated assets inside the trust, avoid immediate capital gains tax, and receive an income stream. The trust pays tax as it distributes income to you, which spreads the gain over years and can keep you in lower brackets.

Installment sales under Section 453 spread the gain over the payment period. If you’re selling an investment property or a business, structuring the deal as an installment sale can keep your annual income below the $1 million threshold and avoid the top 13.3% rate.

• Tax-loss harvesting — offset gains with losses, wash sale rules apply
• 1031 exchanges — defer gains on rental and investment real estate by reinvesting
• Installment sales — spread the gain over multiple years to stay in lower brackets
• Opportunity Zone investments — defer and potentially reduce gains reinvested within 180 days
• Charitable giving of appreciated assets — donate stock or property and avoid capital gains entirely