Who this page is for
You are thinking about buying, selling, renting out a room, adding an ADU (a second small home on your lot), or moving out and keeping the old place, and you want to know how each choice is taxed before you commit. Maybe you have read conflicting things on forums about how much of a home-sale profit is really tax-free, the tax that can claw back past write-offs when you sell, or how California's Prop 13 protects a long-held assessment. This page lays out the federal and California treatment for six common setups, in plain language, with every rule sourced. It is a map, not personal advice.
Capital gains: what is law today, and what is only pending
The exclusion has not been doubled. Current federal law lets you exclude up to $250,000 of gain (single) or $500,000 (married filing jointly) on the sale of your primary residence, if you owned and lived in it at least 2 of the last 5 years. That is IRC Section 121. These amounts have been unchanged since 1997, and they are not indexed for inflation. Source
That frozen number is the whole story in the Bay Area. Since 1997, home values across much of the region have multiplied, but the exclusion has not moved a dollar. A long-held home can carry a gain that dwarfs $500,000, and every dollar above the exclusion is taxable, at ordinary rates on the California side, up to its 13.3% top marginal rate.
What is pending, not law. A bill in Congress, H.R. 1340, the More Homes on the Market Act, proposes to double the exclusion to $500,000 single and $1,000,000 married, and to index it to inflation from a 2024 base year. As of July 2026, it has been referred to the House Ways and Means Committee. It has not advanced out of committee, has not passed either chamber, and is not law. Do not plan around the higher amounts; they are not currently available. Source
What the 2025 law did not do. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, made large federal tax changes, but it did not change the Section 121 home-sale exclusion. The $250,000 / $500,000 amounts still stand. Do not confuse "a big 2025 tax law passed" with "the home-sale exclusion doubled". Source
This reflects federal law and pending bills as of July 2026. Legislation can change; confirm the current status of any bill before relying on it.
Prop 13 and the long-hold advantage
California's Proposition 13 (Prop 13) is why a neighbor who bought decades ago can pay far less property tax than the family that just moved in next door.
Base-year value. Your property's assessed value is set to its market value at purchase or change of ownership (the "base-year value"). For most owners, the purchase price becomes the base. Source
The 2%-per-year cap. The assessed value can rise at most 2% per year (tied to the California Consumer Price Index, capped at 2%), regardless of how fast market value climbs. This is why long-held Bay Area homes carry assessments far below market. Source
What resets it, and what does not. Two things reset the assessed value: a change in ownership (a sale, most transfers, or an inheritance) and new construction. A refinance or normal repairs do not trigger a reassessment. Source
Adding an ADU: partial, not full. Building an ADU is "new construction", but the assessor reassesses only the ADU. It adds the ADU's value to your existing base-year value (a "blended" assessment), and your main home keeps its low Prop 13 base. Subdividing a lot can trigger a separate reassessment of the split parcels. The lot-split base-year allocation is assessor-specific, so confirm it with the county assessor and a CPA. Source
Prop 19, moving after 55. Homeowners 55 and older (or severely disabled, or disaster victims) can transfer their low Prop 13 base-year value to a replacement primary residence anywhere in California, up to 3 times. This took effect April 1, 2021, and replaced the old Prop 60/90 one-time, same-county rules. Source
Prop 19, inheriting a home. Since February 16, 2021, an inherited home is reassessed to market value by default. The parent-child exclusion survives only if both conditions are met: the home was the parent's principal residence (or a family farm), and the child makes it their own primary residence within one year. Even then, only a limited amount (roughly the old base plus about $1,000,000) is protected. This gutted the old Prop 58 unlimited parent-child exclusion. The exact protected amount and the one-year owner-occupancy mechanics are fact-specific, so confirm with a CPA or estate attorney. Source
Frequently asked questions
Do I have to report rent from my roommate, or from renting out a room?
Yes. Rent you receive as an owner is reportable income, and it goes on Schedule E along with the deductible rented-share of your expenses. Whether you receive a 1099-K from a payment app does not determine whether the rent is taxable; rent you receive is reportable regardless of what form, if any, is issued. California follows the same reporting, and gives no QBI deduction on the rental-share income. Source
If I turn my house into a rental, do I lose the $250,000 / $500,000 capital-gains exclusion?
Not right away. You keep the Section 121 exclusion as long as you sell within the window where you owned and used the home as your main home 2 of the last 5 years. Rent it too long, past roughly 3 years after you move out, and you lose it. Renting after you move out does not, by itself, prorate the exclusion, but the depreciation you took while renting is always taxable. California conforms to these rules. Source
How much of my mortgage interest and property tax can I actually deduct?
On a primary residence, mortgage interest is an itemized deduction on acquisition debt up to $750,000 (or $1,000,000 if grandfathered from before December 15, 2017). Property tax is itemized under the SALT cap, which OBBBA raised to $40,000 for 2025 (indexed up about 1% per year through 2029), phasing down above $500,000 of MAGI to a $10,000 floor, then reverting to $10,000 in 2030. California does not conform to the federal $750,000 cap: on your California return, acquisition-debt interest is deductible on up to $1,000,000 (the pre-2018 federal limit), so the slice between $750,000 and $1,000,000 that is disallowed federally is added back as a California adjustment. Confirm the details for your tax year with a CPA. Source
What can I write off if I rent out part of my home?
Split your expenses between personal and rental use by a reasonable method, usually square footage or number of rooms. The rental share of mortgage interest, property tax, insurance, utilities, and repairs is deductible on Schedule E, and you depreciate the rented portion of the building over 27.5 years. Your personal share stays an itemized deduction under the usual caps. The allocation must be reasonable and consistent, because a made-up percentage invites an audit adjustment. Source
Will building an ADU reassess my whole house and blow up my Prop 13 basis?
No. An ADU is "new construction", but the assessor reassesses only the ADU and adds its value to your existing base in a "blended" assessment. Your main home keeps its low Prop 13 base-year value. Splitting the lot is a separate matter and can trigger its own reassessment of the resulting parcels; that allocation is assessor-specific, so confirm with the county assessor. Source
Do I really owe capital gains when I sell? I thought home sales were tax-free.
Only up to the exclusion. On a qualifying primary residence you can exclude $250,000 of gain (single) or $500,000 (married filing jointly); anything above that is taxable. The amounts have been frozen since 1997 and are not indexed for inflation, so in high-appreciation Bay Area sales, gain over the cap is common. California taxes that excess as ordinary income, up to its 13.3% top marginal rate. Source
Can I 1031-exchange my house, or my former home, into another property?
A primary residence does not qualify for a 1031 exchange, which is for investment real property only. A former home that you have converted to a genuine rental can qualify on its investment portion, and there is a combined 121-plus-1031 approach that applies the exclusion first and defers the rest, under Revenue Procedure 2005-14 and the Revenue Procedure 2008-16 safe harbor. You cannot exchange directly into a property you intend to occupy as your home. Source
When I sell my rental, what is this depreciation recapture I keep hearing about?
When you sell, the gain up to the depreciation you took (or that was "allowable") is taxed at a maximum 25% federal rate. That is depreciation recapture, and it applies on an "allowed or allowable" basis, meaning you owe it even if you never actually claimed the depreciation. California has no 25% cap: it taxes the recapture portion as ordinary income, up to its 13.3% top marginal rate. Source
Why can't I deduct my rental loss against my salary?
Rental losses are generally passive, so they offset passive income, not wages. A special allowance lets active participants deduct up to $25,000 of rental losses against other income, but that allowance phases out between $100,000 and $150,000 of MAGI and disappears above it, a range many Bay Area households exceed. Losses you cannot use are not lost: they are suspended, carry forward, and are released when you sell in a fully taxable sale. Active participation, the phase-out, and real-estate-professional status are fact-specific, so confirm with a CPA. Source
I rent my vacation place a few weeks a year. Do I report it?
The 14-day rule governs. If you rent the home fewer than 15 days in the whole year, that rental income is tax-free and unreported, and you take no rental deductions. At 15 days or more, all of the rental income is reportable. Rent it more than that, and once your personal use exceeds the greater of 14 days or 10% of rental days, the home becomes a "residence" and rental deductions are capped at rental income. California generally follows these federal personal-use rules. Source
