Direct Answer: California landlords face three main taxes: state income tax on rental income (1% to 13.3% based on bracket), property tax at 1% of assessed value plus voter-approved bonds, and transient occupancy tax (8-15%) for short-term rentals under 30 days. Property tax increases are capped at 2% annually under Proposition 13, but reassessment occurs upon sale or ownership transfer. Rental income is taxed as ordinary income on both federal and California returns, with deductions available for mortgage interest, repairs, property management fees, and depreciation.
A San Francisco landlord called us last month after receiving a $28,000 California tax bill he didn't expect. He purchased a rental property in Oakland for $850,000, assumed his property taxes would stay at $8,500 annually, and failed to report $42,000 in rental income on his California return. The Franchise Tax Board caught the unreported income through Form 1099-MISC matching, assessed back taxes at California's 9.3% rate, and added penalties. That call could have been avoided with basic understanding of California's rental property tax requirements.
California has the highest state income tax in the nation (up to 13.3%), strict property tax rules under Proposition 13, and aggressive enforcement against unreported rental income. Since 2015, our team has helped 200+ landlords navigate California's complex tax landscape, and the most common problem is underestimating the total tax burden. Here's what every California rental property owner needs to know about income taxes, property taxes, deductions, and compliance requirements.
California taxes all rental income as ordinary income on your state tax return, identical to how you report wages or business income. If you earn $50,000 from your job and $30,000 from rental properties, California taxes you on $80,000 total income.
There's no special rental income rate, it's all taxed at your marginal tax bracket, which ranges from 1% to 13.3% depending on your total taxable income.
You must report rental income on both your federal return (Schedule E) and your California return (Schedule E California version). The forms look similar but have different rules for certain deductions. California doesn't conform to all federal tax provisions, creating situations where something deductible federally isn't deductible in California, or vice versa.
California's tax brackets for 2025 are progressive. Single filers pay 1% on the first $10,412, scaling up to 9.3% on income between $61,214 and $312,686, then 10.3% up to $375,221, 11.3% up to $625,369, and 12.3% on income above $625,369. An additional 1% mental health services tax applies to income above $1 million, creating an effective top rate of 13.3% for California's highest earners.
Real example: A landlord earning $150,000 from employment plus $40,000 from rental properties pays California income tax on $190,000 total. The rental portion at that income level gets taxed at approximately 9.3% state tax ($3,720) plus federal taxes. Compare this to Texas or Florida where rental income incurs zero state income tax, and California's cost becomes clear.
Quarterly estimated tax payments are required if you owe more than $500 annually. Most landlords with significant rental income must make quarterly payments to both the IRS and California Franchise Tax Board. Miss these payments, and you'll face underpayment penalties of 5-8% annually. Managing tax filing deadlines across multiple jurisdictions prevents these costly penalties.
California property tax is capped at 1% of assessed value under Proposition 13, passed in 1978. However, your actual property tax bill typically runs 1.1-1.3% because voter-approved bonds, special assessments, and Mello-Roos districts add charges on top of the base 1% rate. These additional charges vary by city and county, with some areas charging significantly more than others.
Your property's assessed value is the purchase price, not current market value. When you buy a rental property for $600,000, your assessed value starts at $600,000. This assessed value can only increase 2% per year maximum under Proposition 13, even if market values skyrocket. This creates massive tax advantages for long-term owners in appreciating markets like San Francisco, Los Angeles, and San Diego.
Reassessment occurs in three scenarios: purchase/sale of property, new construction or major improvements, and ownership transfers (with limited exceptions). When you sell and a new owner purchases, the property gets reassessed to the new purchase price. A property bought in 1990 for $200,000 might have a current assessed value of $340,000 (2% annual increases), but market value of $1.2 million. The new buyer's assessed value becomes $1.2 million, creating a property tax bill of $13,200 instead of $3,740.
Certain transfers avoid reassessment under Propositions 58, 193, and 19 (modified in 2021). Parent-to-child transfers of primary residences up to $1 million in assessed value avoid reassessment.
Transfers between spouses also avoid reassessment. However, Proposition 19 eliminated most parent-child exemptions for rental properties starting February 16, 2021, creating tax increases for inheritors.
Property taxes are due in two installments: first half due November 1 (delinquent after December 10), second half due February 1 (delinquent after April 10). Missing these deadlines triggers 10% penalties immediately, plus 1.5% monthly interest. Counties can eventually foreclose on properties with delinquent taxes exceeding five years, though this is rare for occupied rental properties.
Mortgage interest is fully deductible on both federal and California returns for rental properties. Unlike personal residences (which face limits), rental property mortgage interest has no cap. If you pay $30,000 in mortgage interest annually on a rental property, you deduct the entire $30,000 against your rental income. This applies to acquisition loans, refinances, and even second mortgages used for rental property purposes.
Property taxes paid on rental properties are fully deductible. The $10,000 state and local tax (SALT) deduction cap that affects personal returns doesn't apply to rental property taxes reported on Schedule E. Pay $8,000 in property taxes on your rental? Deduct all $8,000. This is one area where California rental property owners have an advantage over homeowners who hit SALT caps.
Repairs and maintenance are immediately deductible, while improvements must be depreciated over time. Replacing a broken water heater ($1,200) is a repair, deduct it immediately. Replacing all appliances with high-end versions ($8,000) is an improvement, depreciate it over 5-7 years. The distinction matters significantly for cash flow and current-year tax liability. Repairs restore property to original condition; improvements add value or extend useful life.
Property management fees (typically 8-12% of rent), HOA dues, insurance premiums, utilities you pay, pest control, landscaping, advertising, legal fees, and travel to manage the property are all deductible. Keep receipts for everything. The IRS and California Franchise Tax Board both require documentation for claimed expenses. A $500 repair deduction without a receipt becomes a $500 increase in taxable income during an audit.
Depreciation provides a non-cash deduction that reduces taxable income without requiring any current expenditure. Residential rental properties depreciate over 27.5 years. A $550,000 rental property (excluding land value of $150,000) generates $14,545 in annual depreciation deduction ($400,000 ÷ 27.5 years). This deduction reduces your taxable income each year, though you'll pay depreciation recapture tax when you eventually sell at 25% federal rate plus California rates.
Rentals under 30 days are classified as short-term rentals and face transient occupancy tax (TOT), also called hotel tax. Cities and counties charge TOT at rates ranging from 8% to 15% depending on location. San Francisco charges 14%, Los Angeles 14%, San Diego 10.5%, Sacramento 12%. This tax is collected from guests and remitted to local tax authorities, similar to sales tax.
You must register with your local jurisdiction and obtain a TOT permit before accepting any short-term rental guests. Operating without a permit triggers penalties of $500-5,000 per violation, plus back taxes and interest. Some cities like Santa Monica and San Francisco have additional registration requirements beyond just TOT permits, including business licenses and annual safety inspections.
Short-term rental income is reported differently if you provide substantial services. Rentals with daily maid service, concierge services, or meal service might be classified as business income rather than rental income. This changes your tax reporting from Schedule E to Schedule C, potentially subjecting you to self-employment tax (15.3%) on net profits. The IRS uses a seven-factor test examining the level of services provided.
Many California cities limit short-term rentals to primary residences only or cap rental days at 90-120 per year. Los Angeles limits short-term rentals to primary residences for no more than 120 days annually. San Francisco requires host residence during rentals and limits non-hosted rentals to 90 days per year. Violating these ordinances triggers fines of $1,000-5,000 per day, and cities actively enforce through Airbnb and VRBO data sharing agreements.
California requires marketplace facilitators (Airbnb, VRBO) to collect and remit TOT in many jurisdictions, but not all. You remain legally responsible for ensuring TOT is paid, even if the platform claims to handle it. Verify with your city that TOT is actually being remitted, because platforms occasionally miscategorize locations or fail to remit properly, leaving you liable for back taxes.
California requires 3.33% withholding on real estate sales by non-residents. If you're a California resident selling California property, no withholding applies. But if you're a Nevada resident selling your California rental property, California withholds 3.33% of the gross sales price to ensure they collect taxes owed. You can request a withholding waiver or reduction by filing Form 593-C before closing if you're doing a 1031 exchange or expect no tax liability.
Capital gains on rental property sales are taxed as ordinary income by California, not at lower federal capital gains rates. While federal law taxes long-term capital gains at 0%, 15%, or 20% depending on income, California taxes all capital gains as regular income at your marginal rate up to 13.3%. Sell a rental property with $200,000 in gains? California wants $26,600 (at the top bracket) while the IRS wants $40,000 (20% federal rate plus 3.8% net investment income tax).
Depreciation recapture is taxed at 25% federally plus your California marginal rate. If you claimed $100,000 in depreciation deductions over your ownership period, you'll pay $25,000 federal tax plus $9,300-13,300 California tax on that recaptured depreciation when you sell. This is on top of capital gains taxes on the actual appreciation. Many landlords forget about depreciation recapture and get shocked by their tax bill at closing.
1031 exchanges defer both federal and California taxes if executed properly. You sell your California rental property and purchase a replacement property (anywhere in the U.S.) within strict timelines: identify replacement properties within 45 days, close within 180 days. Both federal and California taxes get deferred, though California still withholds 3.33% at closing that you recover when filing your tax return. Understanding state-specific 1031 exchange requirements prevents costly mistakes during cross-state transactions.
Installment sales spread your gain over multiple years, potentially keeping you in lower tax brackets. Seller financing where the buyer pays you over 5-10 years means you report gains as you receive payments, not all in the year of sale. This strategy works particularly well for landlords approaching retirement who want to convert property equity into steady income without massive one-time tax hits.
Passive activity loss rules limit your ability to deduct rental losses against non-rental income. Rental activities are generally considered passive unless you qualify as a real estate professional. This means if your rental expenses and depreciation exceed your rental income, creating a loss, you can't automatically deduct that loss against your W-2 wages or business income.
The $25,000 special allowance for rental real estate lets moderate-income landlords deduct up to $25,000 in rental losses against ordinary income. To qualify, you must actively participate (make management decisions, approve tenants, authorize repairs) and have modified adjusted gross income under $100,000. The allowance phases out between $100,000-$150,000 of income, disappearing entirely above $150,000.
California conforms to federal passive activity loss rules with some modifications. Both federal and California limit passive losses, but California has different phase-out thresholds for certain credits and may treat some activities differently. Most landlords face identical treatment at both levels, but complex situations require careful analysis.
Real estate professional status provides an exemption from passive loss limitations. To qualify, you must spend more than 750 hours per year in real property trades or businesses and more than 50% of your working time in such activities. Material participation in each rental activity is also required. This status is difficult for most landlords with full-time jobs to achieve, but it's valuable for real estate investors who dedicate their career to property management.
Suspended passive losses carry forward indefinitely until you have passive income to offset them or until you dispose of the property in a taxable sale. If you generate $15,000 in rental losses annually but can only deduct $10,000 due to passive loss limits, the unused $5,000 carries forward. After 10 years, you'd have $50,000 in suspended losses. When you sell the property, all suspended losses become deductible, reducing your capital gains tax.
California requires specific disclosures that don't exist in most states. Landlords must provide lead-based paint disclosures for pre-1978 properties, military ordnance disclosures for properties near former military bases, death disclosures for deaths occurring within three years, and Megan's Law database information. Failure to provide required disclosures can void leases or trigger lawsuits.
Form 1099-MISC must be issued to service providers you pay $600+ annually. Your property manager, handyman, or landscaper who receives $600 or more in a year must receive a 1099-MISC by January 31st, with a copy filed with the IRS and California Franchise Tax Board. Failure to file 1099s triggers penalties of $50-290 per form, and the IRS can disallow your deductions if you didn't file required 1099s.
Rent control laws in cities like Los Angeles, San Francisco, Oakland, and Berkeley limit annual rent increases and require just cause for evictions. These laws affect your property's cash flow and resale value. Properties under rent control typically sell at 20-40% discounts compared to non-controlled properties due to restricted income growth. Factor this into your investment analysis when buying California rental properties.
California's habitability requirements exceed most other states. Landlords must provide weather-proof roofs, working plumbing and heating, safe electrical systems, and pest-free conditions. Failure to maintain habitable conditions gives tenants the right to repair-and-deduct, withhold rent, or move out without penalty. Maintaining proper documentation of repairs and preventive maintenance protects you in disputes.
AB 1482 (statewide rent control) limits annual rent increases to 5% plus CPI (maximum 10% total) for properties 15+ years old. This applies to most California rentals not covered by local rent control. Understand which properties qualify for exemptions: single-family homes where the landlord owns fewer than two properties, condos, and new construction built within the last 15 years.
Cost segregation studies accelerate depreciation by identifying property components that depreciate faster than 27.5 years. Instead of depreciating your entire $500,000 rental property over 27.5 years ($18,182 annually), a cost segregation study might identify $150,000 in assets that depreciate over 5-15 years, creating larger early-year deductions. This strategy works best for properties costing $500,000+ and provides immediate tax savings.
Maximize all available deductions through meticulous record-keeping. Track every expense with receipts, categorize them properly, and maintain mileage logs for property-related travel. California landlords in the 13.3% bracket save $13.30 in state taxes plus $37-40 in federal taxes for every $100 in documented deductions. That's $50 saved per $100 spent on legitimate deductible expenses.
Timing income and expenses around year-end can optimize your tax position. If you're in a high-income year, prepay January property taxes in December, accelerate repairs, or purchase equipment before year-end to increase current-year deductions. If you're in a low-income year, defer expenses to the following year when deductions have more value. This is especially relevant when combining strategic year-end tax planning with business income fluctuations.
Converting your rental property to a primary residence before selling can provide capital gains exclusion benefits. Live in the property for 2 of the last 5 years before selling, and you can exclude $250,000 (single) or $500,000 (married) of capital gains from federal taxes. California offers the same exclusion. This strategy requires careful planning but saves enormous amounts on highly appreciated properties.
Establishing residency in a no-tax state before selling California rentals can eliminate California state income tax on the sale. Move to Texas, Nevada, or Florida, establish bona fide residency (183+ days, driver's license, voter registration, primary residence), and then sell your California rental properties as a non-resident. California will withhold 3.33% but you can claim a refund since you're not a California resident. This requires authentic residency change, not just paper documentation, California aggressively audits these situations.
California taxes rental income as ordinary income at rates from 1% to 13.3% depending on your total taxable income. A landlord earning $100,000 total (including rental income) pays approximately 9.3% California tax on the rental portion, plus federal taxes at your bracket. You also pay property tax at 1% of assessed value plus local bonds. Combined effective tax rates on rental income typically range from 30-50% for middle-to-upper income landlords.
Yes, property management fees are fully deductible as rental expenses on both federal and California returns. If you pay 10% of rent to a property manager ($2,000 monthly rent = $200 management fee), you deduct $2,400 annually. Keep detailed records showing the management company's name, EIN, services provided, and payment amounts. Issue Form 1099-MISC if you pay them $600+ annually.
Transient occupancy tax (TOT) is California's hotel tax applied to rentals under 30 days. Rates vary by city: San Francisco 14%, Los Angeles 14%, San Diego 10.5%, Sacramento 12%. You collect TOT from guests and remit it to your local tax authority, typically monthly or quarterly. Register for a TOT permit before accepting any short-term rental guests, operating without a permit triggers $500-5,000 penalties plus back taxes.
Yes, Proposition 13's 1% property tax rate and 2% annual assessment increase limit apply to all California real property, including rentals. Your property tax is based on purchase price, not market value, and can only increase 2% per year unless ownership transfers or major improvements occur. This creates significant tax advantages for long-term owners in appreciating markets, a property bought in 2000 for $300,000 now worth $1.5 million still has taxes based on roughly $480,000 assessed value.
The California Franchise Tax Board matches 1099-MISC forms from property managers and payment processors to your tax return. Unreported rental income triggers assessments for back taxes (1-13.3%), plus 20% accuracy-related penalties, plus interest accruing at 5-8% annually. On $40,000 unreported rental income, expect a bill of $7,000-10,000 in taxes plus $1,400-2,000 penalties plus interest. California aggressively pursues unreported rental income through automated matching programs.
Yes, properly executed 1031 exchanges defer both federal and California capital gains taxes. However, California withholds 3.33% at closing even on exchanges, file Form 593-C to request a waiver or reduction. You must identify replacement property within 45 days and close within 180 days. The replacement property can be in any U.S. state, not just California. Taxes are deferred, not eliminated, you eventually pay when you sell without exchanging.
Rental losses can only offset rental income unless you qualify for the $25,000 special allowance or real estate professional status. The $25,000 allowance lets you deduct rental losses against W-2 income if you actively participate and earn under $100,000 modified adjusted gross income. Above $150,000, no allowance is available. Unused losses suspend and carry forward until you have passive income or sell the property in a taxable transaction.
Yes, if your rental income exceeds $30,000 annually or you own multiple properties. California's 13.3% top rate makes tax mistakes expensive, a $5,000 missed deduction costs $665 in state taxes plus federal taxes. Professional tax preparation for California rental properties typically costs $400-800 but often saves 5-10x that amount through proper deduction maximization, depreciation optimization, and compliance with California's unique rules. The complexity of combining federal and California requirements justifies professional help.
California rental property owners face the nation's highest state income taxes (up to 13.3%) combined with strict compliance requirements and aggressive enforcement. The key to minimizing your tax burden is understanding all three tax layers, income tax on rental profits, property tax at 1% of assessed value, and transient occupancy tax for short-term rentals, while maximizing every available deduction.
Proposition 13 provides long-term property tax stability that partially offsets California's high income tax rates, especially in appreciating markets. Proper documentation of every expense, strategic timing of income and deductions, and careful compliance with California-specific requirements prevent costly penalties. Most landlords earning $40,000+ annually from California rentals benefit from professional tax guidance due to the complexity of combining federal and state rules.
Since 2015, Madras Accountancy has helped 200+ property investors navigate California's rental property tax requirements, from proper expense categorization to 1031 exchange execution and multi-state compliance. If you're managing California rental properties and need expert guidance on tax optimization, deduction maximization, or compliance requirements, our team can help you minimize your tax burden while staying fully compliant with both federal and California regulations.
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January 13, 2026
The IRS treats repairs as immediately deductible expenses that restore property to its original condition, while capital improvements must be capitalized and depreciated over 27.5-39 years.
January 13, 2026
An IRS 1031 exchange (named for Internal Revenue Code Section 1031) allows real estate investors to defer capital gains taxes when selling investment property by reinvesting proceeds into like-kind replacement property.
