Taxes are inevitable, but they’re also important to understand if you’re buying or selling a home. For California buyers and sellers, understanding real estate taxes can be the difference between a successful transaction and a nightmare. Here’s what you need to know.
They say that nothing is certain except for death and taxes. While taxes are anything but fun, they’re a necessary part of life — and of real estate transactions.
You might not want to spend time understanding the finer points of real estate taxes in California, but if you’re intending on buying or selling a home there, you need to understand some of the basics in order to protect yourself.
Not only can understanding real estate taxes save you time and money, but it can also help you avoid potential financial and legal problems down the road. Plus, knowing some basics will help you avoid being surprised when it’s time to sign on the dotted line.
If you’re purchasing a home or selling one in California, this resource should be helpful to you. You’ll learn what types of taxes you’ll have to pay when you sell, how much the transfer taxes will be and who pays them, how to calculate your property taxes, and which tax breaks you might be able to benefit from.
Will You Have to Pay Taxes When You Sell Your Home in California?
Whether or not you have to pay taxes when you sell your home completely depends on how much your home sold for, how long you’d lived there before you sold it, and how much profit you made.
It’s important to realize that there are both federal and state taxes to consider when it comes to selling your home in California.
Federal Taxes
Federally speaking, you can usually qualify to exclude all or most of the income you gained from the sale of a property as long as it was your main home. In other words, if you sell a second home or rental property, you’ll probably be looking at capital gains taxes. But if you’re selling the home you live in, you’re probably safe on the federal side.
Ownership and Use
The federal government uses an Ownership and Use Test to determine who is eligible to exclude profit they made from the sale of their main home come tax time. So long as, in the five years leading up to the sale, you owned the home you’re selling for at least two years and lived in the home as your main house for at least two years, you can exclude profits you make from the sale of that home when you file your taxes.
Gain
For most people, the above tests mean that they won’t have to claim profits they made from the sale of their primary home at tax time. However, you also have to consider your gains. If you’ve gained profit from the sale of your home, you can usually only keep up to $250,000 of that profit tax-free.
After that point, you’ll have to pay a capital gains tax on the remaining profit.
That being said, if you’re married and you file jointly, the amount of gains, or profit, that you’re able to keep without being taxed is doubled to $500,000 in most cases.
If you’re eligible to exclude all of your gains on your taxes, you won’t have to report any of it as income. However, if you do end up with gains that have to be included, make sure to get a Schedule D, often referred to as Form 1040, and include it in your tax filings.
Loss
You can’t deduct a loss from the sale of your main home at tax time. The above exclusions and benefits only apply to those who have made gains, or profits, on their home sale. However, you may be able to exclude losses on secondary properties. You’ll have to discuss your unique situation with a tax professional to know for sure.
In California
As far as your state taxes go, any time real estate is transferred between parties (so between a buyer and a seller), you have to document the transaction. This documentation has to be recorded at the county recorder’s office. This is the only way that a legal change of ownership can be recorded.
How Much Are Real Estate Transfer Taxes in California (and Who Pays Them?)
When the document mentioned above is recorded, a transfer tax is imposed. Basically, a transfer tax is a tax that is charged any time property like a vehicle or piece of real estate changes hands.
Who Pays the Transfer Tax?
Unlike many aspects of real estate transactions, who pays the transfer tax is largely negotiable.
That being said, historically in California if you’re in Northern California the buyer pays this tax, but if you’re in Southern California, the seller pays the transfer tax.
How Much is the Transfer Tax?
As of 2014, the county transfer tax in most of California is $1.10 for every $1,000 of the sale price of the property. Another way to say this is that the transfer tax is 0.11%. A few cities collect their own transfer taxes, as well, which are charged in addition to the state transfer tax.
If you live in Los Angeles, San Francisco, or Riverside, just to name a few, you’ll be paying an additional transfer tax. Los Angeles’ transfer tax is around 0.45%, so if you’re selling a home there worth $500,000 you’ll have to pay a 0.11% transfer tax to the state ($550) and a city transfer tax of $2,250. That would mean you’d have to pay a total of $2,800 in taxes just for transferring your property.
Since Los Angeles is in Southern California, the seller would typically be in charge of that fee.
How to Calculate Property Taxes in California
Calculating property taxes in California can be a complicated process. California law itself is very vague when it comes to many aspects of real estate and the fees and taxes associated with it. Add to that the fact that many cities and localities have their own taxes and regulations, and you can find yourself scratching your head.
However, we can break down some of the basics so you can move forward with your transaction having a better understanding of California property taxes.
Calculating Property Taxes
In 1978, California passed Proposition 13, which defined how property taxes were to be calculated and reassessed. This is still the governing law today when it comes to property taxes in the state of California.
The least you need to know is that the standard tax rate in California is set at 1%, meaning that California residents will pay 1% of their property’s value in real property taxes. When you make the initial purchase of your home, a base year value is set, and it’s upon that value (which is usually also the sales price listed on your deed) that your property taxes are assessed.
Reassessments for Improvements
The same proposition that outlines how much California property taxes should be also puts forth the rules for reassessments. Every year, the county board of assessors will reassess every property under their purview.
Proposition 13 allows the reassessment to create no more than a 2% increase in property taxes. Not surprisingly, the amount that property taxes tend to increase after the annual reassessment is complete is 2%.
Once that 2% increase occurs, you’ll be charged 1% in property taxes on that new rate.
For instance, let’s say you had a home that was originally worth $400,000. You’ve been paying a property tax of 1%, or $4,000. A new year comes around, and your property’s value is reassessed at 2% higher than the original value.
That means your new property value is $408,000. You’ll now be taxed 1% annually on that rate, which means your new property taxes will be $4,080.
Other Taxes
Special taxes and personal property taxes are also allowed under Proposition 13. These taxes are variable and don’t always apply to every person. For a full understanding of whether or not these apply to you, be sure to contact a tax professional and inquire with your local real estate agent as to the trends they’ve witnessed in recent years.
Taxes Vary by Location
Finally, it’s important to understand that property taxes vary greatly by location. For instance, the median home sale price in California is $491,100. Let’s take that value and see how widely property taxes can vary between locations.
In Los Angeles, the average tax rate is 0.793%, which would make the annual property taxes on the median value come to $3,894.
In Orange County, the tax rate is 0.905%, so property taxes on a home valued at the median rate would be $4,444.
There is a wide range of tax rates throughout the state, and shifting your home purchase or sale by one zip code can often result in fairly dramatic differences in what you’ll owe. Make sure to consult with an experienced, local real estate agent who can help you understand your tax situation thoroughly.
Tax Breaks for California Home Buyers and Sellers
All this talk about paying taxes can be scary, but don’t worry. Taxes can help you, too. There are multiple tax breaks available on both the federal and state level for buyers and sellers alike.
General Tax Breaks
There’s a wide range of tax breaks available to you on a federal level. Depreciation (or non-cash expenses), mortgage interest tax deductions, mortgage insurance premium deductions, and deferral of capital gains are all tax breaks available to most people who sell or purchase real estate in a given year.
The cost of services like rental property management or legal consultation fees can also be deducted, as can utilities, travel costs associated with the property (such as the gas mileage used for property inspections), and even the real estate taxes for the gas you used on your rental property.
It’s impossible to list all the general tax breaks that buyers and sellers can expect to see, so be sure to ask both your tax preparer and your real estate agent for advice as you prepare for tax time.
Tax Breaks and Credits for Buyers in California
There are many tax breaks at the state level for home buyers in California. Here’s a brief description of just a few of them.
Homeowners’ Exemption
One tax break that California home buyers can enjoy is the Homeowners’ Exemption. It’s written into the California Constitution and provides a $7,000 reduction in the taxable value of your home so long as it’s owner-occupied and meets certain eligibility requirements.
The Disabled Veterans’ Exemption
This exemption serves to reduce the property tax liability on your main place of residence if you’re a qualified veteran who’s been injured or has suffered illness or disease that is linked to your military service. If you have a surviving spouse, even if they are unmarried, they can usually qualify for this exemption, too.
The exemption has two levels. The Basic Level is often referred to as the $100,000 exemption and is available to all qualifying claimants. There’s an inflation factor built in, though, so you can usually expect to get more than a $100,000 exemption. In 2018, it was over $130,000.
The Low-Income Level, or the $150,000 exemption, is similar to the Basic Level but it’s offered to qualifying claimants who meet certain standards that warrant "low-income." Again, this rate is variable with inflation, so you’ll probably be looking at more than a $150,000 exemption.
Other veterans’ exemptions exist, too, regardless of whether you’re hurt, ill, or qualify for low-income status. Be sure to check with your real estate agent and tax professional for more information if you or a direct relative have served in the military.
Tax Breaks and Write-Offs for Sellers
Sellers in California aren’t left out, either. There are a number of things you can deduct come tax time, as well.
These include but aren’t limited to the cost of any repairs or improvements you made to get your home ready to sell, your mortgage interest, the discount points from your mortgage, moving expenses for active military, property taxes, and many costs related to selling your home.
Tax exposure, as well as tax breaks, can vary greatly from region to region. Sellers and buyers alike should speak with a certified tax professional or accountant in order to minimize your exposure and maximize your savings.
Additionally, it’s critical to work closely with an experienced, local real estate agent. They have in-depth experience in the market, can tell you what others in your situation have paid, and can help you find tax deductions to run by your accountant.