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Selling a Rental Property in California: Taxes and Options

By Matthew Martinez, Founder, CEO & Managing Broker, Diamond Real Estate Group. California DRE #01869679.

When you sell a California rental property, your taxable gain is the sale price, less selling costs, minus your adjusted basis. That basis is reduced by all the depreciation you were allowed to take, whether you claimed it or not. At the federal level, the part of the gain that comes from depreciation is taxed at up to 25%, the rest at long-term capital gain rates, and the 3.8% net investment income tax may also apply. California taxes the whole gain as ordinary income, and escrow usually withholds 3 1/3% of the sales price for the state unless an exemption applies.

This page covers the decision from the seller’s side. It walks through how the tax is figured, what happens at escrow, how tenants change the sale, and the main alternatives to a straight taxable sale: a 1031 exchange, an installment sale, or moving back into the property. Your CPA should run your actual numbers; the goal here is to help you ask the right questions before you list.

How the gain on a rental is calculated

IRS Publication 544 defines gain as the amount you realize from a sale above the property’s adjusted basis. The amount realized is the cash and the fair market value of any property you receive, plus any of your debts the buyer assumes, minus your selling expenses.

Adjusted basis starts with what you paid, adds capital improvements, and subtracts depreciation. Publication 527 says the reduction covers depreciation “you were allowed to claim, even if you didn’t claim it.” Landlords who skipped depreciation in some years still have their basis reduced by it.

A hypothetical example

Say an owner bought a rental house for $600,000, spent $150,000 on improvements and took $200,000 of depreciation over the years. The adjusted basis is $550,000. If the house sells for $1,200,000 with $60,000 of selling costs, the amount realized is $1,140,000 and the gain is $590,000. Of that, up to $200,000 is the depreciation portion, which is taxed differently federally, as the next section explains.

Federal tax: three layers to expect

For property held more than one year, the IRS taxes the gain in layers. A sale that closes in 2026 goes on your 2026 return, so the bracket thresholds below are the IRS’s 2026 figures from Revenue Procedure 2025-32.

Layer	What it covers	Federal rate
Unrecaptured section 1250 gain	Gain equal to depreciation taken on the building	Maximum 25%
Long-term capital gain	The rest of the gain	0%, 15% or 20%; for 2026, 0% applies up to $49,450 of taxable income (single) or $98,900 (married filing jointly), 15% up to $545,500 (single) or $613,700 (married filing jointly), and 20% above that
Net investment income tax	Net gains from real estate and other investments, when modified adjusted gross income exceeds $200,000 (single or head of household), $250,000 (married filing jointly) or $125,000 (married filing separately)	3.8%

Gain on property held in certain nonpassive trades or businesses can fall outside the NIIT, so ask your CPA whether your rental activity changes the answer. If you sell on installments, Schedule D instructions say the unrecaptured section 1250 gain is allocated to the payments as you receive them.

California tax on the sale

The Franchise Tax Board says plainly: “California does not have a lower rate for capital gains,” and “All capital gains are taxed as ordinary income.” The depreciation portion and the rest of the gain are taxed at your regular state rate. When state and federal treatment differ, for example because of different depreciation over the years, the difference is worked out on California Schedule D (540).

A large gain can also push a seller into a higher state bracket for that year, which is one reason sellers model an installment sale or an exchange before they sign a listing. Diamond can’t advise on tax; we can give your adviser a realistic price range and timing to model. A home valuation is the usual starting point.

Withholding at escrow: Form 593 and FIRPTA

California requires withholding on most real estate sales. The real estate escrow person (the escrow company, title company, attorney or qualified intermediary handling the funds) withholds and sends it to the Franchise Tax Board. Withholding is a prepayment toward your California tax, not an extra tax.

Standard rate: 3 1/3% of the sales price.
Alternative calculation: you may elect withholding on your estimated gain instead; the rate for individuals is 12.3% of the gain. On a property with a lot of basis left, this can be lower than 3 1/3% of the price.
Exemptions: no withholding on a sales price of $100,000 or less, on a sale at a loss or zero gain (you complete Part VI of the form), on a qualifying principal residence, on a 1031 exchange (unless you receive more than $1,500 in cash or other property) or on an involuntary conversion.
Installment sales: escrow withholds 3 1/3% of the down payment, and the buyer withholds on the principal of later payments unless the FTB approves your election out.

Our page on Form 593 real estate withholding goes through the form line by line. Foreign sellers face federal withholding as well: under FIRPTA, the buyer generally withholds 15% of the amount realized, with a residence exception for sales of $300,000 or less to a buyer who plans to live in the home.

Selling with tenants in place or vacant

A sale doesn’t end a lease, and in California it isn’t, on its own, a reason to end a tenancy. Under the Tenant Protection Act (Civil Code §1946.2, often called AB 1482), once a tenant has lawfully occupied the unit for 12 months, the owner needs just cause to end the tenancy. The no-fault causes are:

the owner or a listed relative moving in for at least 12 continuous months;
withdrawing the unit from the rental market;
complying with a government or court order to vacate;
demolishing or substantially remodeling the unit, where the work needs the tenant out for at least 30 days.

A no-fault termination requires relocation help equal to one month’s rent, paid within 15 calendar days, or a written waiver of the final month’s rent. The law exempts a separately saleable house or condo if the owner isn’t a REIT, a corporation or an LLC with a corporate member, and the tenant received the statutory exemption notice; for tenancies starting or renewed on or after July 1, 2020, that notice has to be in the lease. The section is set to be repealed on January 1, 2030. Many Bay Area cities add stricter rules; see East Bay rent stabilization by city and our AB 1482 guide for landlords.

Showings with tenants in place

Civil Code §1954 lets an owner enter to show the unit to prospective buyers with reasonable written notice; 24 hours is presumed reasonable. Oral notice is allowed for buyer showings if the tenant was told in writing within the previous 120 days that the property is for sale, and the agent must leave written evidence of the entry. Cooperative tenants make a real difference to presentation, which is why some owners negotiate a move-out instead; see cash for keys in California.

Vacant or occupied?

A vacant property can be sold to owner-occupants as well as investors and can be staged and shown freely. An occupied property usually sells to investors, who will underwrite the existing rent, lease terms and any local restrictions. Our guide to selling a tenant-occupied home compares the two in detail.

Alternatives to a straight taxable sale

Most landlords who sell end up comparing a few structures. The trade-offs below are general; your CPA and, for exchanges, a qualified intermediary decide whether one fits.

Option	What it does	Key trade-off
1031 exchange	Defers federal and California tax by reinvesting in other investment real estate; exempt from Form 593 withholding if you take no more than $1,500 in cash or other property	Strict identification and closing deadlines; you keep owning investment property
Installment sale or seller financing	Spreads gain over the years payments arrive (Form 6252)	Any depreciation recapture income (typically on items such as appliances or cost-segregated components, not straight-line depreciation on the building) is reported in the year of sale even if no payment arrives; interest is ordinary income; you carry the buyer’s credit risk
Move back in and sell later	May allow the home-sale exclusion of up to $250,000 ($500,000 for joint filers) after 2 of the last 5 years of ownership and use	Depreciation after May 6, 1997 can’t be excluded; rental periods after 2008 can reduce the exclusion; a home acquired in a 1031 exchange must be held 5 years first
Taxable sale	Simplest and fastest; you get all the cash at closing	Full federal and California tax in one year

For more detail, see our 1031 exchange guide, seller financing in California and capital gains on a home sale. Publication 523 says a period of rental use after you last lived in the home isn’t counted as nonqualified use, so the order of events matters.

A pre-sale checklist for landlords

Rebuild your basis. Find the original closing statement, records of capital improvements and the depreciation schedules from past returns.
Get a tax estimate. Have your CPA estimate the federal and California tax, and decide whether to elect the Form 593 alternative calculation.
Organize the leases. Gather leases, rent ledgers, security deposit records, any AB 1482 exemption notice and any local rent registration. For buildings with several units, prepare estoppel certificates.
Decide vacant or occupied. Check the just-cause and relocation rules first, including any city ordinance.
Choose the structure before you list. A 1031 exchange needs a qualified intermediary in place before closing, and an installment sale needs terms your attorney has drafted.
Price it. Price against the right buyer pool: owner-occupant comparable sales for a vacant house, or income-based pricing for occupied or multiunit property. See selling a multifamily property.

If you need a property manager to keep the unit leased until closing, or a tax professional, Diamond may refer you to partners we work with; you’re free to choose any provider.

Questions people ask

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

It depends on your gain, your income and how long you owned the property. Federally, the depreciation portion is taxed at up to 25%, the rest at 0%, 15% or 20%, and the 3.8% NIIT may apply above income thresholds. California adds tax at your ordinary income rate on the entire gain.

What is depreciation recapture on a rental property?

For a residential rental, the gain equal to the depreciation you took (or could have taken) on the building is called unrecaptured section 1250 gain. Federally it’s taxed at a maximum of 25% rather than the lower capital gain rates. It can’t be excluded even if the property later becomes your home.

Can I avoid California’s 3 1/3% withholding?

You may qualify for an exemption, such as a sale at a loss, a 1031 exchange, a qualifying principal residence or a price of $100,000 or less. You can also elect withholding on your estimated gain instead of the price. Either way, the withholding counts toward your California tax.

Can I evict my tenant to sell the property?

Not just because you’re selling. Under Civil Code §1946.2, you need a listed just cause after 12 months of tenancy, such as an owner move-in or taking the unit off the rental market, with relocation help for no-fault causes. Local ordinances can be stricter. Many owners sell with the tenant in place or negotiate a voluntary move-out.

Is an installment sale better than a 1031 exchange?

They solve different problems. An exchange defers the tax but keeps you in investment real estate. An installment sale lets you exit and spread the gain over time, but any depreciation recapture income (for example on appliances or cost-segregated components) is taxed in the year of sale, and you take on the buyer’s credit risk.

Can I move into my rental to avoid capital gains tax?

Partly, in some cases. After living there 2 of the 5 years before the sale, you may exclude up to $250,000 ($500,000 for joint filers). Depreciation taken after May 6, 1997 isn’t excludable, and rental years after 2008 can reduce the exclusion.

Do I have to file anything with the FTB when I sell?

Escrow files Form 593 and sends the withholding. You report the sale on your California return for the year of sale and claim the withholding there.

This is general information, not legal or tax advice; talk to a CPA or California tax adviser, and a real estate attorney for tenant questions, about your situation.

If you own a rental in Sonoma, Napa, Marin, San Francisco or the East Bay and are deciding whether to sell, start with a pricing conversation that your CPA can use. Visit our investor services page or see how we handle listing a property.

Sources & notes

Last reviewed October 2026 by Matthew Martinez.