Selling a Home Out of State

[freddytax]

This might be a tricky question.  My domicile is in Nevada where there is no state income tax.  I sold my home in California and fully understand that I need to pay CA state income tax on the proceeds.  The problem that I'm running into is that most tax software wants to create the state return using information from the IRS 1040.  This might not seem like a big deal but what happens is that the CA state return contains AGI that includes income (quite a lot) that was not realized in CA AND then the state income tax is computed on this huge AGI where it should really just be the proceeds from the home.  I suggested to one tax preparer to create a 1040 that ONLY contains the proceeds from the home and then a state return will be based on THAT AGI.  Now of course this is not a valid 1040.  Any thoughts?

[DawnC]

Any gains on the sale of the house in CA is CA-sourced income.  The CA return should start with federal AGI.  Did you live in CA at all in 2023?   If so, you need to complete a Part-Year resident return for CA.   If you did not live in CA at all in 2023, you need to prepare a Non-resident return for CA.   Instructions for each are linked.   

California Filing Requirements

Part-year residents. Taxpayers must file if total taxable California income (income from all sources while a California resident and California-source income while a nonresident) is more than the amount in either chart for filing status, above.

Nonresidents. Taxpayers must file if they have any California source income and income from all sources is more than the amount in either chart for filing status, above.

When you go through the state return, you will be able to allocate or specify what income is California sourced.   Any gains on the sale of the house in CA is CA sourced income.  Rest assured, TurboTax can prepare your state return, correctly, no matter what your residency status is.   

[freddytax]

But why would the AGI for CA include income NOT sourced in CA?  This elevates my CA AGI considerably and increases the tax rate from .0636 (home proceeds only) to .0821 (all income included).  This adds $7,000 in taxes.  In other words, why does CA get to use a higher tax rate based on income that was not earned in their state?

[freddytax]

And to further clarify, yes the tax software allows me to put in $0 for all income not home sale related and the taxable income will come out correct.  That is not the issue.  This issue is the elevated tax rate based on the inflated AGI.  So in other words, AGI vs. taxable income = apples to oranges comparison = two completely different things.

[DawnC]

As stated above, the CA state return starts with federal AGI.   If the house sale is the only thing CA-sourced, all other income gets subtracted out.   Look at Schedule CA, Part IV, Line 1 - - that is your CA AGI - this is the number your tax is based off of.   

**Nonresidents who received California-source income, file Form 540NR, California Nonresident or Part-Year Resident Income Tax Return.  California taxes all income received while a resident of California and the income received from California sources while a nonresident.  Income and adjustment items from all sources are reported on Schedule CA (540NR), California Adjustments—Nonresidents or Part-Year Residents.  Deductions, exemption credits, and tax credits are prorated by a ratio of California AGI to total AGI

[freddytax]

Let me see if I can net this out further.  Why is CA interested in my Nevada sourced income?  If CA would charge me the same tax rate for home sale only vs. ALL income that would be fine and make much more sense to me.  Again, the tax rate is based on CGI and THEN gets applied to taxable income which, yes, is home sale only.

[freddytax]

What you may not be seeing is that the tax rate is figured on AGI BEFORE Schedule CA itemized deductions.  And part of that math equation comes from the CA tax table that, again, should only be based on CA income.  Unfortunately it is not.

[freddytax]

And final thought, here's what CA Franchise Tax Board is saying:  "we will tax you on income that was earned outside of CA."  So if I lived in a state outside of CA that has income tax I end up paying double on any income outside of that CA home sale, e.g., dividends, interest, W2 income all which are included in that tax rate schedule computation.

[freddytax]

Just a side note, the tax software added my employer HSA contributions because CA treats this as income.  News flash:  I don't work in CA!!! 🙂  That's the problem with using the 1040 and W2 to create the state return.

[SusanY1]

Many states, including California, start from the federal AGI when computing state taxable income and make adjustments (additions and subtractions) based on areas where the law doesn't conform.

Sometimes those adjustments are made to the income, and other times they are made to the tax, after using the full federal AGI to set the tax rate.  This is the expected behavior and it is determined by the laws in the states (which vary considerably).

For states that use a different formula to start, there's typically a different number in Box 16 on Form W2 to adjust for the variations in the law. 

The 1040 and W2 are used in the state returns where they are required to be, such as in California.  California uses the same form for nonresidents as for part-year residents, and all income, whether earned in California or not, is required to be reported and then adjusted.  

California first adjusts for areas where the state does not conform with federal law (such as interest on HSAs) and then adjusts for the income earned out of state per California's instructions.   

As you work through the state interview for California, the adjustments that are needed will be made so that  your home sale will be taxed according to California law - which isn't as simple, unfortunately, as just selecting the income from California and taxing it without regard to other income.

 

[freddytax]

Thank you!!  Can I make the adjustment on line 14 of CA 540NR = California Adjustments - which comes from line 27 of Schedule CA (540NR)?  This way the AGI number does not make it look like I live and work in CA.  It's not perfect but it gets the tax closer to where I think it should be.

[KrisD15]

According to the State of California:

"For taxable years beginning on or after January 1, 2002, if you are a nonresident or a part-year resident, you determine your California tax by multiplying your California taxable income by an effective tax rate. The effective tax rate is the California tax on all income as if you were a California resident for the current taxable year and for all prior taxable years for any carryover items, deferred income, suspended losses, or suspended deductions, divided by that income.'

So yes, a taxpayer living in Nevada that earned 2,000,000 in Nevada and realized a 300,000 Capital gain for selling a rental in California will pay more California State Tax for that Capital Gain than a taxpayer living in Nevada that earned 30,000 in Nevada and realized a 300,000 Capital gain for selling a rental in California.

[freddytax]

Thanks, KrisD!  That is the most clear, concise explanation yet and thank you to everyone that replied.  I've wrestled with this question because, to me, it is just so illogical.  I never thought for once that the tax software was doing something wrong but rather something I was missing.