For Californians with substantial investments, understanding how capital gains taxes work is critical to maximizing returns and minimizing tax liabilities. California’s approach to capital gains tax is distinct from the federal system, and knowing the nuances of how both tax authorities apply their rules can help taxpayers devise strategies to reduce their tax burden. As 2025 approaches, it’s important to take proactive steps in tax planning, especially with the potential for changes in tax laws.
What Are Capital Gains?
Capital gains are the profits made from selling assets like stocks, real estate, or other investments. These gains represent the difference between the sale price and the purchase price of an asset. There are two types of capital gains:
- Realized Capital Gains: These occur when you sell an asset and lock in the profit.
- Unrealized Capital Gains: These are the gains on assets that have appreciated in value but have not yet been sold. While unrealized gains increase your net worth, they are not taxable until realized.
How Long-Term and Short-Term Capital Gains Differ
The tax treatment of capital gains varies based on the length of time the asset is held before sale:
- Short-Term Capital Gains: If an asset is sold within one year of purchase, the gain is considered short-term and taxed at the same rate as ordinary income. Short-term capital gains are typically taxed at higher rates compared to long-term gains.
- Long-Term Capital Gains: If the asset is held for more than a year before being sold, the gain is long-term and taxed at a preferential rate, lower than the rate for ordinary income.
Federal Capital Gains Tax Overview for 2025
The federal tax treatment for capital gains depends on whether they are short-term or long-term:
- Short-Term Capital Gains: These are taxed at ordinary income tax rates. For single filers in 2025, these rates range from 10% to 37%, depending on your total income.
- Long-Term Capital Gains: These are taxed at a reduced rate based on income levels:
- For single filers, the rate is 0% for taxable income up to $48,350, 15% for income between $48,350 and $533,400, and 20% for income above $533,400.
- For married couples filing jointly, the 0% rate applies to taxable income up to $96,700, 15% for income between $96,700 and $600,050, and 20% for income exceeding $600,050.
Additionally, a 3.8% Net Investment Income Tax (NIIT) applies to capital gains for individuals with modified adjusted gross income (MAGI) over $200,000 ($250,000 for married couples).
California’s Approach to Capital Gains Tax in 2025
California differs significantly from the federal government in its treatment of capital gains. The state does not distinguish between short-term and long-term capital gains. Instead, all capital gains are taxed as ordinary income, subject to California’s income tax rates.
In 2025, the state income tax rates will be as follows:
| Taxable Income (Single Filers) | Taxable Income (Married Filing Jointly) | Tax Rate on This Income |
|---|---|---|
| $0 to $10,756 | $0 to $21,512 | 1% |
| $10,756 to $25,499 | $21,512 to $50,998 | 2% |
| $25,499 to $40,245 | $50,998 to $80,490 | 4% |
| $40,245 to $55,866 | $80,490 to $111,732 | 6% |
| $55,866 to $70,606 | $111,732 to $141,212 | 8% |
| $70,606 to $360,659 | $141,212 to $721,318 | 9.30% |
| $360,659 to $432,787 | $721,318 to $865,574 | 10.30% |
| $432,787 to $721,314 | $865,574 to $1,442,628 | 11.30% |
| $721,314 to $1,000,000 | $1,442,628 to $2,000,000 | 12.30% |
| $1,000,000 or more | $2,000,000 or more | 13.30% |
Given that California taxes capital gains as ordinary income, high-income earners can face significant tax rates on their investment gains, making it essential to consider strategies for minimizing liability.
Example: California Investor Scenario
Consider an investor, Alex, who purchased 5,000 shares of Tesla stock in 2021 at $200 per share, and decides to sell the shares in 2025 for $600 per share, realizing a gain of $2,000,000. Here’s a breakdown of the taxes Alex would owe:
Federal Taxes
Given Alex’s $2,000,000 in capital gains, this would be treated as a long-term capital gain, placing Alex in the 20% federal tax bracket for long-term gains (for single filers, this applies to income above $533,400). This means Alex will owe 15% on the portion of the gain between $48,350 and $533,400, and 20% on the remaining amount. In addition, the 3.8% NIIT will apply to the portion of the gain above $200,000, adding further tax liability.
California State Taxes
As a California resident, Alex’s $2,000,000 gain will be taxed at California’s ordinary income tax rates. Given Alex’s income, he will fall into the top bracket of 13.3%. California’s progressive tax system means Alex will pay different rates on different portions of the gain, based on the state’s income brackets.
In total, the combination of federal and state taxes could result in a substantial tax liability. To reduce the impact, Alex may want to explore tax-saving strategies, such as charitable donations, tax-advantaged investments, or deferring gains through specialized investment structures.
Tax Planning Strategies to Reduce Capital Gains Tax
Given the significant tax burden that capital gains can create, there are several strategies available to reduce your taxable income or defer the tax liability:
1. Charitable Remainder Trusts (CRTs)
A CRT allows individuals to transfer appreciated assets into a trust before selling them, which can defer capital gains taxes. The trust itself is tax-exempt, and the grantor receives income from the trust for a specified period, with the remainder going to charity. This allows for a significant tax deferral and can improve after-tax returns.
2. Investing in Renewable Energy Projects
Investments in renewable energy projects may qualify for government tax incentives, including tax credits and accelerated depreciation, which can reduce taxable capital gains. This type of investment can provide a strong return on investment, factoring in both tax savings and cash flow.
3. Oil and Gas Investments
Oil and gas well investments offer the opportunity to write off drilling costs, providing immediate tax deductions. These investments often yield strong returns in the early years, and substantial tax benefits can be realized in the first year.
4. Maximize Retirement Contributions
Contributing to retirement accounts, such as 401(k)s and IRAs, can help reduce taxable income and, in turn, lower both ordinary income and capital gains taxes. By maxing out contributions to these accounts, individuals can reduce their taxable base while saving for the future.
5. Charitable Lead Annuity Trusts (CLATs)
A CLAT allows individuals to make charitable gifts while receiving an income tax deduction. The trust provides charitable donations while retaining the remainder interest for personal use, allowing for tax savings upfront while still benefiting from future wealth distribution.
Conclusion
Navigating capital gains taxes in California requires strategic planning, especially for those with large portfolios or substantial gains. Understanding how both federal and state tax rates will impact your gains in 2025 is essential to minimizing your tax burden. By utilizing tax-saving strategies such as CRTs, renewable energy investments, or retirement account contributions, you can significantly reduce the taxes owed on your capital gains, allowing you to retain more of your wealth.
Learn more: Robert Hall & Associates | Los Angeles Tax Preparation & Consulting