Rental Income Tax Rate in California: What Real Estate Investors Must Know for 2025

Every year, California real estate investors overlook thousands in avoidable taxes because they misunderstand how the rental income tax rate in California actually works. Most believe their only options are to eat high tax bills or risk the wrath of the Franchise Tax Board by pushing gray-area deductions. Here’s the truth: With the right tactics, you can legally keep far more of your rental profits—often $10,000–$40,000 more—if you understand and apply the latest 2025 changes, IRS rules, and California quirks.

Quick Answer: Rental income in California is taxed at both the state and federal levels, with rates ranging from 1%–13.3% for state income (depending on your total income bracket) and up to 37% federally. Investors who actively manage their properties can unlock advanced deductions—depreciation, repairs, mortgage interest, and more—that can reduce their effective tax rate considerably if structured and documented correctly. (See IRS Publication 527 for details.)

This guide breaks down five power strategies for slashing your rental income tax in California for 2025—complete with new rules, hard numbers, pitfalls to avoid, and a KDA client case study. Whether you own a single-family in Orange County, a duplex in LA, or a small multifamily portfolio across the state, you’ll discover what actually moves the needle under the 2025 rules.

This information is current as of 10/9/2025. Tax laws change frequently. Verify updates with IRS or FTB if reading this later.

How Rental Income Is Taxed in California

Start with a basic: Rental income is all the payments you receive for the use or occupation of property. In California, rental income is considered ordinary income. That means it gets lumped together with your salary, business income, and other earnings for both your state and federal tax calculations.

• State Tax Rate: 1% to 13.3%, depending on total taxable income. (See California Schedule CA)
• Federal Tax Rate: Follows individual income tax brackets, with the top at 37% for 2025.

When evaluating the rental income tax rate California investors actually pay, it’s crucial to distinguish between marginal and effective rates. While the state top bracket hits 13.3%, most landlords’ effective state tax on rental income falls between 8%–10% after deductions like depreciation and mortgage interest. For high earners, layering in federal and NIIT (3.8%) can push total taxation close to 45%. Strategic planning—like timing repairs or leveraging 1031 exchanges—can significantly lower that effective burden year over year.

Many out-of-state investors overlook that California taxes all income generated by property located in-state—even if you live outside California. A Delaware or Nevada LLC doesn’t escape CA tax here. Documentation and transparency are non-negotiable.

Pro Tip: All rental profits must also be reported to the IRS on Schedule E (Form 1040).

Maximize Deductions: The Secret to Cutting Your Effective Tax Rate

Deductions—done right—are a rental investor’s most powerful shield. Ordinary and necessary expenses incurred to produce or collect income are fully deductible on both your state and federal return (see IRS Publication 535). Key areas include:

• Mortgage interest
• Property taxes (CA rules apply: only amounts used to produce rental income count)
• Repairs (not improvements)
• Management fees and commissions
• Depreciation
• Insurance and utilities

Many California investors overpay because they misallocate expenses between personal use and rental use, or lose receipts that would legitimize a deduction in an audit. For a $2 million multifamily earning $140,000 in annual rent, correct allocation and substantiation of expenses routinely cuts $25,000+ from the tax bill.

If you want to see this with live scenarios and how they transform tax returns, check out our complete tax strategies for California real estate investors.

KDA Case Study: Real Estate Investor Boosts After-Tax Returns with Repair and Depreciation Tactics

Let’s talk real numbers. Jennifer owns three rental condos in Irvine, CA, generating $92,000 net rental income annually. When she first came to KDA, she was reporting net income of $74,000 and paying roughly $21,700 in combined state and federal tax.

KDA’s review flagged that Jennifer was treating all roof work as an “improvement” and capitalizing it (forcing multi-year deductions) rather than splitting true repairs from upgrades. We also adjusted her depreciation schedules, properly incorporating $24,000 of assets that’d never been depreciated. With receipts and new cost allocations, Jennifer’s adjusted net income dropped to $53,200 and her taxes fell to just $13,400. $8,300 in KDA fees returned $8,300 in tax savings year one, and continued savings after.

Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.

Why Most Investors Overpay: Misclassifying Expenses and Passive Loss Rules

Here’s where most California rental owners get burned. The IRS and FTB have strict rules about passive losses—a category that encompasses most rental real estate unless you’re a “real estate professional” by IRS standards (see Topic 425). Passive losses in excess of passive income can’t offset W-2 or business profits, with a $25,000 exception for lower-income investors phased out at $100,000+ income.

Red Flag Alert: If you and your spouse make more than $150,000, passive losses may be suspended and carried forward—but not applied to your other earnings. If your CPA doesn’t know to position you as a real estate professional (material participation, documented hours), you could overpay by $10,000–$30,000 annually.

Pro Tip: Routine expense tracking and time logs can be the difference between five-figure write-offs now versus years of carryforward suspense.

Mid-Article Resource: Professional Preparation = Real Results

If you want personalized support to ensure deductions are maximized and all reporting aligns with California’s constantly evolving rules, consider our real estate tax preparation services.

Depreciation: The Silent Tax Shield for California Investors

Depreciation is the most significant deduction for property investors, giving you a non-cash write-off based on the value of your rental property’s structure (not land) over 27.5 years (per IRS Publication 946). For a $1,100,000 property with $800,000 allocable to structure, that’s $29,090 “invisible expense” per year reducing taxable rental income. Many miss additional depreciation on appliances and improvements that qualify for faster write-offs under Section 179 or bonus depreciation rules—which are phasing out after 2025.

• Federal: Annual amounts per property type.
• California: May adjust for state-specific conformity or recapture—don’t assume parity.

Myth Bust: Not all improvements have to be capitalized for 27.5 years. The IRS allows certain asset groupings for bonus depreciation and shorter recovery periods.

Capital Gains and CA Surtax: Should You Sell or Hold?

Selling a rental in California? You’ll face:

• Federal long-term capital gains tax: Up to 20% for high earners
• Net Investment Income Tax (NIIT): 3.8% for higher AGI thresholds
• California capital gains: Treated as regular income (1%–13.3%)
• Potential surcharges, like the Mansion Tax for high-value properties

With a $450,000 gain on a long-held multifamily in the Bay Area, you can easily lose $140,000+ to taxes if you don’t plan ahead and leverage like-kind exchanges (1031 exchange rules), opportunity zones, installment sales, or trust structures. The timing of sale, recapture computations, and documentation are everything—and a bad move can cost you a quarter-million overnight.

Pro Tip: Use deferred sales trusts or 1031 exchanges to avoid immediate tax and keep more funds compounding. Always review new thresholds for high-net-worth sellers under the 2025 permanent $15M exemption. (Form 709 guidance.)

Red Flag: Traps That Trigger CA Franchise Tax Board Audits

Many investors try to outsmart the state by allocating high “management” fees—especially to family members—or treating personal costs as deductible. The FTB has stepped up rental income audits in 2025, particularly for short- and medium-term rentals advertised on platforms like Airbnb and VRBO. If you cannot produce contemporaneous records, written agreements, and support for expense allocations, the penalties can be severe.

Red Flag Alert: Understated rental income or inflated expense reporting is one of the top three triggers for FTB audits in 2025. See details in CA FTB rental income guidance.

FAQ: Critical Rental Income Questions for California Investors

Do I owe California income tax if I own a property here but live in another state?

Yes. If your rental property is in California, all rental income from that property is subject to CA income tax regardless of your personal residency. See FTB nonresident filing requirements.

How do I calculate my deductible expenses?

Track every eligible expense directly related to renting your property—this includes repairs, property management, insurance, mortgage interest, and depreciation. Keep thorough receipts and a clear, dated log for each item. Refer to IRS rules for residential rental property.

Can I deduct losses from my rental against other income?

Only partially and under specific conditions. If you’re not classified as a real estate professional and your modified adjusted gross income is over $150,000, the passive activity loss deduction phases out. Check IRS Topic 425 for more.

What if I use my rental part-time for personal use?

This requires strict allocation of deductibles per IRS and FTB rules. If you rent less than 15 days a year, the income may be excluded, but days used personally must be excluded from expense calculations. (See Publication 527.)

Book Your Real Estate Tax Strategy Session

If you’re serious about lowering your rental property tax burden in California, our team will show you 3 actionable tactics tailored to your portfolio in your first meeting. Stop leaving thousands on the table—schedule your strategy call and unlock what your CPA might be missing. Click here to book your consultation now.