How to Avoid Capital Gains Tax on Rental Property in California

Selling a California rental property is rarely the clean capital gain owners expect. Four separate taxes can land on the same sale, and California is the highest-tax state in the country. Here's the full picture — and how to keep more of it.

The four taxes on a California rental sale

Federal capital gains — up to 20% on the appreciation.
Depreciation recapture — the depreciation you deducted over the years is recaptured; the straight-line portion is "unrecaptured §1250 gain" taxed up to 25% federally.
3.8% Net Investment Income Tax — on top, once your income clears the threshold.
California tax — up to 13.3%, as ordinary income, with no preferential capital-gains rate and no honoring of the federal 25% recapture cap.

Ways to defer or reduce it

1031 exchange — defers everything, but you must buy a replacement property within strict deadlines.
Structured installment sale (§453) — spread the gain over years; no replacement property needed; ideal if you want to exit real estate.
Charitable remainder trust — for income + charitable intent.

The recapture catch:

Depreciation recapture is generally recognized in the year of sale — even in an installment sale.
So spreading helps the capital-gain portion most; plan the recapture deliberately.
In California, recapture is taxed as ordinary income up to 13.3% — there's no 25% cap.

The takeaway

If you want to keep owning real estate, a 1031 may fit. If you want out — or can't find a replacement — a structured installment sale spreads the capital-gain portion across years and gives you guaranteed income. Either way, the move is to plan before you list.

Frequently asked questions

How do I avoid capital gains tax on rental property in California?

You can defer it with a 1031 exchange (requires buying a replacement property) or a structured installment sale under IRC §453 (spreads the gain over years with no replacement needed). California taxes the gain as ordinary income up to 13.3%, so deferral is especially valuable.

Do I have to pay depreciation recapture when I sell my rental?

Yes. The depreciation you deducted over the years is recaptured at sale — the straight-line portion is unrecaptured §1250 gain, taxed up to 25% federally. California taxes it as ordinary income with no 25% cap.

Can a structured installment sale defer depreciation recapture?

Generally no — recapture is recognized in the year of sale even under the installment method. A structured installment sale mainly spreads the capital-gain portion of the sale, so the recapture should be planned for separately.

What's the difference between a 1031 exchange and a structured installment sale for a rental?

A 1031 defers tax only if you reinvest in another like-kind property within strict deadlines. A structured installment sale spreads the gain over years without buying anything — better if you want to exit real estate entirely.

How much tax will I pay selling a rental property in California?

Potentially four layers: up to 20% federal capital gains, up to 25% recapture on prior depreciation, the 3.8% NIIT, and California ordinary tax up to 13.3%. The combined bite can approach or exceed a third of the gain — which is why deferral planning matters.

Thinking about a big sale?

Before you sign anything, run your numbers with someone who structures the deal to be tax-smart and audit-ready from day one.

Call 213-414-2808 Run the Numbers →