Will I pay capital gains tax when I sell my house in California?

Probably some, and in Palo Alto often a lot. The federal exclusion is $250,000 for a single filer and $500,000 for a married couple filing jointly, and it has not moved since 1997 — it is not indexed to inflation. A Palo Alto house bought decades ago can have a gain several times the exclusion, and everything above it is taxable federally and again by California, which taxes capital gains as ordinary income at rates up to 13.3%. The single most useful thing a seller can do is find the records of every improvement ever made, because those raise the basis and shrink the gain.

The exclusion, and why it runs out here

If you have owned the home and lived in it as your main residence for at least two of the last five years, you can exclude $250,000 of gain as a single filer or $500,000 filing jointly. The two years of use need not be continuous, and you must not have claimed the exclusion on another home in the previous two years.

The number to sit with: those amounts were set in 1997 and have never been indexed to inflation. Everything else in the tax code moves with prices each year. This does not.

A Palo Alto house bought in 1990 for $400,000 and selling at $3.5M has a gain of roughly $3.1M before adjustments. A married couple excludes $500,000 of it. The remaining $2.6M is taxable — federally at long-term capital gains rates, by California as ordinary income, and potentially by the 3.8% Net Investment Income Tax on top.

Source: Internal Revenue Code §121; IRS Publication 523. Amounts confirmed unchanged for 2026.

The three layers

Federal long-term capital gains, for 2026: 0% up to $98,900 of taxable income filing jointly, 15% to $613,700, and 20% above that. (Rev. Proc. 2025-32.)

Net Investment Income Tax, 3.8%, once modified adjusted gross income passes $250,000 jointly or $200,000 single. Those thresholds are also not indexed — the IRS says so explicitly. Gain you exclude under the §121 rule is excluded from this too; only the gain above the exclusion counts.

California, which has no separate capital gains rate at all. The gain is ordinary income, at rates up to 13.3% — the 12.3% top bracket plus the 1% levy on income over a million dollars.

What actually reduces the bill

Improvements raise your basis. Repairs do not. The IRS line is whether the work added value, prolonged the home’s life, or adapted it to a new use. A new kitchen, a room addition, a replaced roof, new windows, a rebuilt deck, landscaping that is genuinely new: basis. Repainting, fixing a leak, servicing the furnace: not.

Selling costs come off the top. Commission, escrow, title and transfer tax are subtracted from the sale price to get the “amount realized”, and the gain is calculated from that figure — so they reduce the taxable gain directly.

Which is why the receipts matter so much. Thirty years of documented improvements on a Palo Alto house can easily be several hundred thousand dollars of basis, and several hundred thousand dollars of basis at these rates is real money. Permits, contractor invoices, cancelled cheques, credit card statements — anything that establishes what was done and what it cost.

Start looking before you list, not during escrow.

The withholding nobody warns you about

California withholds 3⅓% of the gross sale price at closing unless the seller certifies an exemption on Form 593. On a $4M sale that is about $133,000.

The principal-residence exemption is one of the certifications available, and it is handled through escrow at closing. Getting it wrong does not create a tax — you get the money back eventually — but “eventually” means after you file a return.

If the house was inherited

Different arithmetic entirely, and usually much better. Inherited property generally receives a basis stepped up to its value at the date of death, which can eliminate decades of gain outright. That is its own question, and it is the reason selling a parent’s house soon after inheriting it often produces very little taxable gain.

Not tax advice

Maggie is a listing agent, not a CPA or a tax attorney, and this page is not advice about your return. The figures above are current for 2026 and cited so you or your accountant can check them. On a Palo Alto sale the gain is large enough that an hour with a CPA before you list is among the cheapest money in the whole transaction — sometimes it changes the timing, and occasionally it changes whether you sell this year at all.

You may also see proposals in the news to eliminate capital gains tax on home sales. As of September 2026 none has become law.