Disclaimer: This article is intended for informational purposes only and does not constitute tax or legal advice. Tax laws are subject to change. Consult a licensed CPA, tax attorney, or financial advisor before making any decisions regarding the sale of a real estate asset.
The Tax Bill Most Sellers Don't See Coming
For Bay Area multifamily investors, the decision to sell isn't just about price — it's about what you actually walk away with after taxes.
Without understanding the full tax picture ahead of time, equity built over years can erode faster than expected. Here is what every investor needs to know before listing.
Federal Capital Gains: The Baseline
When you sell an investment property held for more than one year, federal long-term capital gains rates apply:
- 0% for lower-income filers
- 15% for most investors
- 20% for high-income earners
If you held the property for one year or less, the gain is taxed as ordinary income at rates up to 37%. Most Bay Area investors selling properties held for several years will land in the 15% or 20% bracket. These thresholds adjust annually — confirm the current year's figures with your CPA.
California Adds a Significant Layer
California taxes all capital gains as ordinary income with no preferential rate for long-term holdings. Per the California Franchise Tax Board, every dollar of gain is added to your total taxable income and taxed at the same progressive rates as wages.
California's top marginal rate is 13.3% — the highest state-level capital gains rate in the country. This applies to taxable income above approximately:
- $1,000,000 for single filers
- $2,149,988 for married filing jointly (2025 figures — verify with your CPA)
For high-income Bay Area investors, the combined federal and California rate can reach 33% or higher before depreciation recapture is factored in.
Depreciation Recapture: The Hidden Tax
Over the years you owned the property, you likely claimed depreciation deductions that reduced your taxable income. The IRS allows residential rental property to be depreciated over 27.5 years.
When you sell, the IRS recaptures that benefit. The portion of your gain tied to prior depreciation deductions is taxed federally at a maximum rate of 25%. California taxes the recaptured amount as ordinary income with no rate cap.
This is one of the most overlooked components of a multifamily sale — and one of the most important to model before going to market.
The Net Investment Income Tax
High-income investors also face a federal 3.8% Net Investment Income Tax (NIIT) on top of standard capital gains rates. This applies to modified adjusted gross income above:
- $200,000 for single filers
- $250,000 for married filing jointly
These thresholds are not inflation-adjusted, meaning more investors are pulled in every year. For investors subject to NIIT, the effective federal rate on long-term gains reaches 23.8% before California taxes are added.
The 1031 Exchange: The Most Powerful Deferral Tool Available
A 1031 exchange allows investors to defer capital gains taxes entirely by reinvesting sale proceeds into a qualifying like-kind replacement property. It is the most widely used tax deferral strategy among Bay Area multifamily investors.
Key rules:
- Replacement property must be identified within 45 days of closing
- Transaction must close within 180 days
- Replacement property must be of equal or greater value to fully defer the gain
- A qualified intermediary must hold the funds — the seller cannot take possession of proceeds
If the final replacement property is held until death, heirs receive a stepped-up basis that can eliminate the deferred tax liability entirely.
California's Clawback Provision: Know Before You Exchange Out of State
California conforms to federal 1031 exchange rules but adds a critical layer: if you exchange a California property for a replacement property located outside of California, California does not release its claim on the deferred gain.
Under California Revenue and Taxation Code Sections 18032 and 24953, the Franchise Tax Board requires investors to file Form FTB 3840 annually until the deferred gain is recognized. When the out-of-state replacement property is eventually sold without another exchange, California collects its deferred state taxes on the original gain — regardless of where you live at that time.
Investors considering an out-of-state exchange should discuss Form FTB 3840 obligations and long-term clawback exposure with a California tax advisor before executing the transaction.
How to Protect Your Net Proceeds
Before listing a multifamily property in the Bay Area, take these steps:
- Engage a real estate CPA early — model your estimated tax liability before negotiating a price
- Calculate your adjusted cost basis — original purchase price, plus capital improvements, minus cumulative depreciation
- Evaluate 1031 exchange options — identify potential replacement properties and confirm the timeline works
- Understand your FTB 3840 obligations if considering an out-of-state exchange
- Model multiple exit scenarios — straight sale, installment sale, and 1031 exchange — before committing to a strategy
The R&Z Group's Role in This Conversation
The decision to sell a multifamily property has as much to do with tax strategy as it does with market timing. The R&Z Group works with investors across the Bay Area at every stage of the process — from evaluating whether it makes sense to sell, to identifying 1031 exchange replacement properties, to helping buyers acquire the right asset on the other side. Specializing in properties ranging from duplexes to 100+ unit apartment communities, The R&Z Group brings financial precision and local market expertise to every transaction, and works alongside clients' CPAs and tax advisors to make sure the investment strategy and tax strategy are aligned from day one.
FAQ
How much capital gains tax will I pay when selling an apartment building in California?
For high-income investors, the combined federal long-term capital gains rate, California state tax, NIIT, and depreciation recapture can push the effective rate on the full gain above 37%. Every situation is different — work with a CPA to model your specific numbers before making any decisions.
Can I avoid capital gains tax when selling a rental property in California?
California offers no capital gains exclusion for investment properties. However, investors can legally defer taxes through a 1031 exchange. Installment sales are another strategy worth exploring with a tax advisor depending on your goals.
What is depreciation recapture?
It is the IRS mechanism for taxing back the depreciation deductions you claimed during ownership — at a maximum federal rate of 25%, separate from the capital gains tax on appreciation. California taxes the recaptured amount as ordinary income with no cap.
Does California honor the 1031 exchange tax deferral?
Yes — but California's clawback provision means that if you exchange into an out-of-state replacement property, California will still collect deferred state taxes when that property is eventually sold without another exchange. Annual Form FTB 3840 filings are required to track the deferred gain. Discuss this with a California tax advisor before executing an out-of-state exchange.
If you're looking to sell a multifamily property in San Jose, Oakland, Redwood City, San Mateo, Burlingame, Daly City, Hayward, Palo Alto, Menlo Park, Santa Clara, Sunnyvale, Berkeley, or Concord — or anywhere across the Bay Area and beyond — The R&Z Group is the multifamily real estate broker built for investors who expect results. Whether it's a duplex or a 100-unit apartment complex, from maximizing your sale price to navigating a 1031 exchange into a stronger-performing asset, we bring local market expertise, financial precision, and a proven track record to every transaction. Contact us today to discuss your multifamily investment goals.
Contact The R&Z Group:
Ray Rodriguez | (650) 405-0743 | Lic# 01999734
Tony Zizzo | (650) 770-8356 | Lic# 01962093
