Before making any investment, it’s essential to fully grasp the amount one can expect to pay in taxes; that way, you can ensure that you’re optimizing your return by paying what you need.
Learn how California capital gains taxes on real estate affects your real estate investing with Christina and how much tax you can expect on your capital assets.
What Are Capital Gains Taxes?
Investments are capital infusions into assets that will increase in value as the market increases. Value-increasing assets can refer to: securities, stocks, cars, boats, and of course, real estate.
When the investor sells an asset, the gains made by that asset are realized; they liquidate the value increase of the asset into real wealth for the investors.
Realized gains are subject to taxes: capital gains taxes. Capital gains taxes are taxes levied on profits an asset earns for an investor after being sold.
When investment assets like a stock or real estate holding are sold, the investor may be required to pay an apportioned amount of that sale price to their federal and state government.
These taxes are only owed after closing costs and escrow have been collected; assets held indefinitely do not require any taxes on their increase in value. Value increases of assets that are unsold by an investor are considered unrealized capital gains.
Once an investor liquidates that asset, they must pay a proportional tax rate on a cost basis based on the profit earned from the sale of their primary residence or rental property in the tax year during which the asset was sold.
What’s the History of Capital Gains Taxes?
Capital gains taxes have their legal basis in the 16th Amendment. The 16th Amendment stipulates that:
“The Congress shall have the power to lay and collect taxes on incomes, from whatever sources derived, without apportionment among the several States, and without regard to any census or enumeration.”
Before the 16th Amendment, most of the federal government’s tax base was generated by tariffs and excise taxes like the sales of goods and services. These kinds of taxes occur during transactions domestic in the case of excise taxes and international in the case of tariffs.
Income taxes do not require commercial exchange; they are direct taxes on regular income earned by legal entities: individuals and corporations.
Capital gains constitute income earned as per the 16th Amendment. As investing became more complex and lucrative at the turn of the century, the federal government enacted legislation that made realized gains from trading a special tax.
The total profit earned by realized gains was subject to tax at a maximum of 7 percent.
Since their inception, the taxes made available by the 16th Amendment have evolved and become more nuanced. States have adopted specific income tax legislation; capital gains taxes have grown specific in the rates at which they tax and what level of income gets taxed in the first place.
Today, capital gains can be divided into short-term capital gains taxes and long-term capital gains taxes.
What Are Short-Term Capital Gains Taxes?
Short-term capital gains taxes are levied for gains made under a year at a specific rate.
There are many different ways to trade: most real estate strategies tend to be long-term investments for homeowners. However, there are opportunities in real estate investing and elsewhere to make substantial gains in under a year.
An asset’s holding period refers to the time investors have held it. Holding periods sold within a year are relatively short holding periods.
These fast-paced gains are taxed at a different rate than assets held a long while before being sold; they are generally taxed higher than their long-term counterparts.
What Are Short-Term Capital Gains Tax Rates?
Short-term capital gains may tax your profit anywhere from 13 to 37%.
The rate you are charged depends on whether the asset was sold within a year, your filing status, and your income level.
In general, short-term capital gains are taxed like ordinary income; the taxes on the profits earned by an asset will correspond to the tax bracket determined by your income level.
The current short-term capital gains taxes rates are as follows:
Single taxpayers:
- 10 percent: Up to $10,275
- 12 percent: $10,276 to $41,775
- 22 percent: $41,776 to $89,975
- 24 percent: $89,076 to $170,050
- 32 percent: $170,051 to $215,950
- 35 percent: $215,951 to $539,900
- 37 percent: Over $539,900
Head of household:
- 10 percent: Up to $14,650
- 12 percent: $14,651 to $55,900
- 22 percent: $55,901 to $89,050
- 24 percent: $89,051 to $170,050
- 32 percent: $170,051 to $215,950
- 35 percent: $215,951 to $539,900
- 37 percent: Over $539,900
Married filing jointly:
- 10 percent: Up to $20,550
- 12 percent: $20,551 to $83,550
- 22 percent: $83,551 to $178,150
- 24 percent: $178,151 to $340,100
- 32 percent: $340,101 to $431,900
- 34 percent: $431,901 to $647,850
- 37 percent: Over $647,850
Married filing separately:
- 10 percent: Up to $10,275
- 12 percent: $10,276 to $41,775
- 22 percent: $41,776 to $89,075
- 24 percent: $89,076 to $170,050
- 32 percent: $170,051 to $215,950
- 34 percent: $215,951 to $323,925
- 37 percent: Over $323,925
What Are Long-Term Capital Gains Taxes?
Long-term capital gains taxes take effect on gains realized after an extended holding period, usually over a year. Long-term capital gains taxes are more favorable than income taxes; unlike short-term capital gains taxes, long-term capital gains tax rates offer investors a tax exemption.
Keeping capital in the market sustains stability. The reduced rate of long-term capital gains taxes encourages investors to avoid the fast-paced style of investing, like day trading, in favor of less volatile, long-term strategies.
Long-term investments signify an investor’s willingness to see through an investment, with the expectation that it will perform well over an extended period.
Real estate is a famously attractive long-term investment. A real estate asset will rarely be liquified within a year, meaning that real estate assets tend to receive more favorable long-term capital gains tax rates.
What Are Long-Term Capital Gain Tax Rates?
Long-term capital gains tax rates are more favorable for investors; you can expect to pay anywhere from 20 percent to absolutely nothing for your long-term realized gains.
Like short-term gains and income tax rates, the tax rate for long-term capital gains depends on the holding period before they are sold, your income status, and your marital status.
Lower rates correspond to lower income levels and joint filings. What’s more, after the Tax Cuts and Jobs Act of 2017, long-term capital gains rates have dropped lower than ever, ensuring that investors are rewarded for abiding by longer holding periods.
These are the current long-term capital gains tax rates as of 2022:
Single taxpayers :
- 0 percent: $0 to $40,400
- 15 percent: $40,401 to $445,850
- 20 percent: $445,851 or more
Head of household:
- 0 percent: $0 to $54,100
- 15 percent: $54,101 to $473,750
- 20 percent: $473,751 or more
Married, filing jointly:
- 0 percent: $0 to $80,800
- 15 percent: $80,801 to $501,600
- 20 percent: $501,601 or more
Married, filing separately:
- 0 percent: $0 to $40,400
- 15 percent: $40,401 to $250,800
- 20 percent: $250,801 or more
Tax rates for long-term gains are more favorable than short-term tax rates. Real estate is the best way to go for effective, long-term investments. Compared to securities trading, real estate investing is far more illiquid and relatively slow-moving; assets rarely qualify for short-term gains when sold.
While multiple California cities like San Francisco or San Diego may be worth your consideration, consider investing in the Westside of Los Angeles, the premier real estate market in a world-class city.
What’s the Difference Between Federal vs. State Capital Gains?
The 16th Amendment establishes the Constitutional basis that allows the federal government to levy income and capital gains taxes.
Because Constitutional law is the supreme law of the United States, individual states have the right to levy property taxes and capital gains taxes as well, provided they abide by the 16th Amendment.
For investing purposes, you may be required to pay capital gains on taxable income to the federal government and the state where you live.
Capital gains tax rates vary between states; some levy higher capital gains taxes because they have more complicated infrastructures to maintain, while others offer lower rates to attract outside capital to their state.
Understanding the federal capital gains tax and your home state makes a critical difference in what you can expect to pay when you finally liquidate your investment property.
The state of California has the best real estate in the country and the entire world. Here is how capital gains tax rates work in California so you can know what to expect when you acquire premium real estate there.
How Do Capital Gains Taxes Work In California?
California differs from other states because it taxes capital gains as ordinary income. The Golden State uses a state tax bracket to determine how much investors and taxpayers pay at the end of the year.
The California capital gains tax rate functions as a tax on ordinary income over the year, including your recognized gains.
Here are the income tax brackets that California investors should consider when investing in Golden state real estate:
Single taxpayers; or married, filing separately:
- 1 percent: $0 to $9325
- 2 percent: $9,326 to $22,107
- 4 percent: $22,108 to $34,892
- 6 percent: $34,893 to $48,435
- 8 percent: $48,436 to $61,214
- 9.3 percent: $61,215 to $312,686
- 10.3 percent: $312,687 to $375,221
- 11.3 percent: $375,222 to $625,369
- 12.3 percent tax rate: $625,370 or more
Head of household:
- 1 percent: $0 to $18,663
- 2 percent: $18,664 to $44,217
- 4 percent: $44,218 to $56,999
- 6 percent: $57,000 to $70,542
- 8 percent: $70,543 to $83,324
- 9.3 percent: $83,325 to $425,251
- 10.3 percent: $425,252 to $510,303
- 11.3 percent: $510,304 to $805,503
- 12.3 percent: $850,504 or more
Married, filing jointly:
- 1 percent: $0 to $18,650
- 2 percent: $18,651 to $44,214
- 4 percent: $44,215 to $69,784
- 6 percent: $69,785 to $96,870
- 8 percent: $96,871 to $122,428
- 9.3 percent: $122,429 to $625,372
- 10.3 percent: $625,373 to $750,422
- 11.3 percent: $750,443 to $1,250,738
- 12.3 percent: $1,250,739 or more
Getting the Best Return on California Real Estate
California real estate, especially in Los Angeles, is easily among the strongest in the country. Premium real estate comes at premium purchase prices; when factoring additional expenses on your return, like capital gains taxes, having the resources to ensure you’re only paying what you need is essential to optimizing your returns.
Investing with a professional real estate firm equips you with the resources to get the best return possible on your California real estate investments. Firms don’t just have the capital to help you secure the best possible real estate but the understanding of tax law that helps you realize the best returns.
What To Expect From the Experts
Christina has thrived for over four decades as a real estate investment firm in L.A.’s most competitive market: the Westside.
That’s because our firm has the complete background on best practices for real estate investing, tax law, and a network that connects you with the best property in the city.
Get started with us today and get a better return tomorrow.
Sources:
16th Amendment to the U.S. Constitution: Federal Income Tax (1913) | National Archives
Topic No. 409 Capital Gains and Losses | IRS
California State Tax: Rates and Who Pays in 2021-2022 | NerdWallet