| 2005
TAX LAW CHANGES
FOR CAPITAL GAINS
Recent changes to real estate tax laws may affect your
buying and selling decisions. One significant tax law
change involves properties acquired through a 1031 exchange.
For these properties, the Internal Revenue Service (IRS)
has imposed a five-year ownership requirement for eligibility
to the $250,000 (or $500,000 for married couples) exclusion
from capital gains taxes. In a separate move, California's
Franchise Tax Board has eased its real estate withholding
requirements by no longer requiring one as long as a
seller's last use of the property being sold was as
his or her principal residence.
The following hypothetical situation illustrates how
these new rules work. Let's say, in 2001, Ted Taxpayer
acquires a rental property through a 1031 exchange,
and then, in 2003, he moves into that property as his
primary residence. What are the tax consequences if
he now sells the property in 2005?
First, even if Ted has lived in the property for two
of the last five years, he may not qualify for the $250,000
exclusion from capital gains tax when selling his home.
As of October 23, 2004, a taxpayer who acquires property
through a 1031 exchange is not eligible for the $250,000/$500,000
exclusion for the first five years of owning that property.
Here, Ted is not eligible because he's only owned his
property for four years.
CAPITAL GAINS ON REAL ESTATE SALES
President Bush signed The Jobs and Growth Tax Relief
Reconciliation Act of 2003 (the "2003 Act")
on May 28, 2003. The 2003 Act makes important changes
to taxation laws including, among other matters, lower
capital gains tax rates, acceleration of a reduction
in tax rates, increased child tax credits and a reduction
in the so-called marriage penalty. Additionally, the
Taxpayer Relief Act of 1997 (the “1997 Act”)
and the IRS Restructuring and Reform Act of 1998 (the
“1998 Act”) provide for an exclusion from
income for certain amounts of gain from the sale of
a principal residence. This Q&A discusses portions
of the 2003 Act, the 1998 Act and the 1997 Act having
an impact on capital gains treatment for the sale of
real property and providing an exclusion from income
for gains from the sale of a principal residence.
THIS MEMORANDUM IS NECESSARILY GENERAL IN NATURE AND
IS NOT INTENDED TO COVER EVERY FACT SITUATION. SLIGHTLY
DIFFERENT FACTS MAY PRODUCE DIFFERENT RESULTS. ACCORDINGLY,
YOU SHOULD CONSULT A PROFESSIONAL TAX ADVISOR IF ADVICE
IS NEEDED IN CONNECTION WITH A PARTICULAR TRANSACTION.
THIS ANALYSIS IS SUBJECT TO CHANGE AS EXPERIENCE IS
GAINED WITH APPLICATION OF THE PROVISIONS OF THE 2003,
1998 AND 1997 ACTS TO ACTUAL SITUATIONS AND AS THE INTERNAL
REVENUE SERVICE ISSUES GUIDANCE TO THOSE PROVISIONS.
1. SALE OF PRINCIPAL RESIDENCE
Q 1. What happens if I sell my principal residence?
A. Individuals are generally permitted to exclude from
income up to $250,000 ($500,000, in general, for married
couples filing a joint return) realized on the sale
or exchange of their principal residence.
Q 2. May I use this exclusion more than once?
A. Yes, but generally not more than once every two years.
In order to qualify, you must have owned and used the
property as your principal residence for at least two
years during the five-year period ending on the date
of the sale or exchange. In addition, the two-year periods
do not have to be continuous.
Q 3. May I use this exclusion in connection
with Internal Revenue Code ("IRC") section
1034 "rollover" of gain on the sale of my
principal residence if I purchase a home of equal or
greater value?
A. No. The IRC section 1034 provision allowing a delay
in the recognition of gain when purchasing a replacement
residence of equal or greater value was repealed by
the 1997 Act.
Q 4. May I still take a one-time exclusion of
$125,000 of gain from the sale of my principal residence
if I am age 55 years or older?
A. No. This exclusion was also repealed by the 1997
Act.
Q 5. If I have previously used the $125,000
exclusion of gain, am I prohibited from using the new
$250,000 ($500,000 for married couples filing jointly)
exclusion of gain?
A. Generally no. Even if you have previously taken the
one-time $125,000 exclusion, if you are otherwise eligible
for the exclusion you can take advantage of the $250,000
exclusion ($500,000 for married couples filing jointly)
as often as you meet the requirements.
Q 6. How does the exclusion apply to married
couples?
A. The $500,000 exclusion applies to married couples
filing jointly when all of the following conditions
are met:
• Either spouse meets the ownership requirement;
• Both spouses meet the use requirement; and
• Neither spouse has had a sale of their principal
residence in the preceding two years subject to the
exclusion.
Q 7. What if I marry someone who has used the
exclusion within two years prior to our marriage?
A. Even though your spouse has used the exclusion within
two years prior to your marriage, you would still be
allowed a $250,000 exclusion. Once both spouses satisfy
the eligibility requirements and two years have passed
since the last exclusion was allowed to either spouse,
a full $500,000 exclusion would be allowed for the next
sale or exchange of a principal residence.
Q 8. What if I move before I have occupied my
residence for two years or before two years have elapsed
since the last time I sold or exchanged my principal
residence?
A. If you fail to meet either two-year requirement,
you will still be entitled to a pro rata amount of the
exclusion as long as the failure to meet the requirement
is because the sale or exchange is by reason of a change
in place of employment, health or other unforeseen circumstances.
The 1998 Act provides that this ratio is that portion
of the $250,000/$500,000 exclusion equal to the fraction
of the two years that the ownership and use requirement
is met. Therefore, an unmarried taxpayer who owns and
uses a principle residence for one year and then sells
because of a job transfer may exclude up to $125,000
of gain (one-half of the regular $250,000 exclusion).
Example: Ms. Seller purchased and occupied her principal
residence in 1998. One year later, she is transferred
by her employer to another city and sells her house
for a $100,000 gain. Because she occupied her residence
for one-half of the required two years, Ms. Seller is
entitled to exclude up to one-half of the $250,000 otherwise
allowed, thereby covering her entire $100,000 gain.
This is a change from the IRS’s previous position
allowing her to exclude only one-half of her gain, or
$50,000.
Q 9. Are there clarifications to the permissible
reasons for sale or exchange allowing a pro rata exclusion?
A. Yes. Treasury regulations provide clarifications
and safe harbors for the exemptions from the two-year
period. Treasury Regulation 1.121-3T provides that a
sale or exchange is by reason of a change in employment,
health, or unforeseen circumstances only if the primary
reason for the sale or exchange is a change in place
of employment, health or unforeseen circumstances.
The regulation provides the following guidelines and
safe harbors:
Place of Employment
Generally, a sale or exchange is deemed to be a change
in employment if the primary reason for the sale or
exchange is a change in the location of a qualified
individual’s place of employment.
(See Question 10 for a definition of qualified individual.)
The regulation provides a distance safe harbor if (i)
the change of employment occurs during the period of
the taxpayer’s ownership and use of the property
as the taxpayer’s principal residence, and (ii)
the individual’s new place of employment is at
least 50 miles further from the residence sold or exchanged
than was the former place of employment, or, if there
was no former place of employment, the distance between
the individual’s new place of employment and the
residence sold or exchanged is a least 50 miles.
For purposes of the regulation, employment includes
starting a job with a new employer, continuing employment
with the same employer, and starting or continuing self-employment.
Health
A sale or exchange is by reason of health if the primary
reason for the sale or exchange is to obtain, provide,
or facilitate the diagnosis, cure, mitigation, or treatment
of disease, illness, or injury of a qualified individual,
or to obtain or provide medical or personal care for
a qualified individual suffering from a disease, illness
or injury. A sale or exchange that is merely beneficial
to the general health or well-being of the individual
is not a sale or exchange by reason of health.
The regulations provide a safe harbor if a physician
recommends a change of residence for reasons of health.
(See Question 10 for a definition of qualified individual.)
Unforeseen Circumstances
A sale or exchange is by reason of unforeseen circumstances
if the primary reason for the sale or exchange is the
occurrence of an event that the taxpayer does not anticipate
before purchasing and occupying the residence.
The regulations provide a safe harbor for any of the
following events occurring during the taxpayer’s
ownership and use of the residence as the taxpayer’s
principal residence:
1. The involuntary conversion of the residence;
2. Natural or man-made disasters or acts of war or terrorism
resulting in a casualty to the residence;
3. In the case of a qualified individual:
a. Death;
b. The cessation of employment as a result of which
the individual is eligible for unemployment compensation;
c. A change in employment or self-employment that results
in the taxpayer’s inability to pay housing costs
and reasonable basic living expenses for the taxpayer’s
household (including amounts for food, clothing, medical
expenses, taxes, transportation, court-ordered payments,
and expenses reasonably necessary to the production
or income, but not for the maintenance of an affluent
or luxurious standard of living);
d. Divorce or legal separation under a decree of divorce
or separate maintenance;
e. Multiple births resulting from the same pregnancy;
or
4. An event determined by the Commissioner to be an
unforeseen circumstance to the extent provided in published
guidance of general applicability or in a ruling directed
to a specific taxpayer.
(See Question 10 for a definition of qualified individual.)
Q 10. Who is a “qualified individual”?
A. Qualified individual is defined in the regulations
as the taxpayer, the taxpayer’s spouse, a co-owner
of the residence, or a person whose principal place
of abode is in the same household as the taxpayer. For
purposes of the pro-rata exclusion of gain for a sale
or exchange due to health only, a qualified individual
also includes (i) an individual with a relationship
described as a dependent in IRC section 152(a)(1) through
(8), without regard to whether they are actually a dependent,
or (ii) a descendent of the taxpayer’s grandparent.
Q 11. What if I do not qualify for a safe harbor?
A. The regulations provide the following factors, which
may be relevant in determining the taxpayer’s
primary reason for the sale or exchange:
1. The sale or exchange and the circumstances giving
rise to the sale or exchange are proximate in time;
2. The suitability of the property as the taxpayer’s
principal residence materially changes;
3. The taxpayer’s financial ability to maintain
the property materially changes;
4. The taxpayer uses the property as the taxpayer’s
residence during the taxpayer’s ownership of the
property;
5. The circumstances giving rise to the sale or exchange
are not reasonably foreseeable when the taxpayer begins
using the property as the taxpayer’s principal
residence; and
6. The circumstances giving rise to the sale or exchange
occur during the period of the taxpayer’s ownership
and use of the property as the taxpayer’s principal
residence.
Q 12. May I deduct a loss on the sale of my
principal residence?
A. No. Although there were discussions about allowing
homeowners to deduct losses on the sale of their principal
residence, this provision did not become law.
Q 13. If I have gains from the sale of my principal
residence above the $250,000/$500,000 exclusion limits,
what tax rate will I pay?
A. Depending on the length of time you owned your principal
residence, your gain may be taxed at the more favorable
capital gain rates discussed below. See Section II,
below.
Q 14. Are there more special rules?
A. Yes, including, among others, the following:
• A taxpayer can elect not to have the exclusion
apply to any sale or exchange.
• Certain periods an individual resides in a nursing
home on account of physical or mental incapacity are
included as part of the two-year use requirement if
certain other rules apply.
• An individual whose spouse is deceased on the
date of the sale of the property can include the period
the deceased spouse owned and used the property before
death.
• An individual is treated as using the property
as his or her principal residence during any period
of ownership while the individual's spouse or former
spouse is granted use of the property under a divorce
or separation instrument.
Q 15. What happens if I transfer my principal
residence into a revocable living trust?
A. IRC section 676 provides that a grantor (the person
who creates and funds the trust) is treated as the owner
of the property when the grantor retains the power to
revoke the trust and re-vest title in him or herself.
The 2003 Act does not change this provision. This means
that the $250,000 exclusion ($500,000 if married filing
jointly) applies to a sale or exchange by a revocable
living trust so long as the grantor of the trust and
owner of the property before it was conveyed to the
trust are the same person and that person, either as
owner or grantor, has owned and used the property as
his or her principal residence for two of the previous
five years. In other words, because the grantor is still
treated as the owner of the property, the transfer into
the trust is not a taxable event.
Q 16. May I utilize an IRC Section 1031 (tax-differed
exchange) in connection with an owner-occupied residence?
A. No. However, individuals sometimes exchange one rental
property for another planning to move into the acquired
property and, after living in it for two years, sell
it and take advantage of the capital gains exclusion.
This sometimes occurred as soon as three or four years
after the acquisition. As of October 22, 2004, this
is no longer possible. Pursuant to the American Jobs
Creation Act (signed by President Bush on October 22,
2004), a property acquired in a 1031 exchange and later
converted to a principal residence must by owned for
five years from the date of the exchange before the
owner can claim the capital gains exclusion. Therefore,
in order to take advantage of a 1031 exchange and the
capital gains exclusion, the owner must both have used
the acquired property as a principal residence for two
years and owned it for five years.
II. CAPITAL GAINS
Q 17. What are the basic changes to the capital
gains tax structure?
A. Basically, the 2003 Act reduces the maximum rate
on the net capital gains rate of an individual (net
long-term capital gains less net short-term capital
losses) from 20 percent to 15 percent. Net capital gains
previously taxed at 10 percent will be taxed at 5 percent.
Q 18. Has the holding period for long-term capital
gains changed?
A. In order to qualify for long-term capital gains treatment,
property must be held for more than 12 months.
Q 19. Are there further capital gains tax rate
reductions?
A. In 2008, the capital gains tax rate for gains taxed
in the lowest tax bracket (5 percent) will be reduced
to zero.
Q 20. When do the reductions in capital gains
take effect?
A. The 2003 Act took effect May 6, 2003 and applies
to taxable years ending on or after May 6, 2003. There
are special transitional taxation rules for taxable
years including May 6, 2003.
Q 21. Do these capital gains rates expire?
A. Unless Congress extends them, the capital gains rate
reductions will sunset December 31, 2008, at which time
the rates will revert to 20 percent and 10 percent.
Q 22. Are there any changes to depreciation
recapture rules?
A. No. Generally, when selling investment real property,
a tax is imposed on all amounts previously taken as
depreciation. Under prior law, these amounts were taxed
as ordinary income and not capital gains.
The 1997 Act provides for a 25 percent maximum tax rate
on any gain attributable to depreciation already claimed
on the property in the case of real property for which
the maximum tax rate is reduced to 15 and 5 percent.
Although there was an effort to reduce the recapture
rate, no reduction materialized.
Example: Ms. Seller purchases a triplex for $200,000
after January 1, 2001, and takes depreciation deductions
of $50,000 over the six years she owns it. She sells
the duplex for $300,000. Her basis in this property
is reduced to $150,000 because of her deductions for
depreciation, and she would have a $150,000 gain.
Under the 2003 Act, she would be taxed at a 15 percent
(or 5 percent) rate on the $100,000 portion of gain
over her original $200,000 basis and at a 25 percent
rate on the $50,000 portion of gain attributable to
her depreciation deduction.
Q 23. Can you provide a summary of the capital
gains tax rates?
A. Yes. Sales of assets held more than 12 months and
sold on or after May 6, 2003 qualify for the 15 percent
capital gains rate (5 percent for lowest income taxpayers),
with special transitional rules for sales in taxable
years including May 6, 2003. The capital gains rate
reverts to 20 and 10 percents for assets held for more
than 12 months and sold after December 31, 2008.
Q 24. Can I still take advantage of an IRC section
1031 "like-kind" exchange?
A. Yes. The tax-free exchange of "like-kind"
property used in a trade or business is not affected
by the Act.
ANYONE REQUIRING SPECIFIC ADVICE SHOULD CONSULT AN ATTORNEY.
Second, despite this potentially onerous tax liability,
Tom is exempt from the requirement that 3 1/3 percent
of the sales price be withheld from his proceeds. As
of January 1, 2005, a new exemption from the California
withholding requirement is available for sellers whose
last use of the property was their principal residence,
regardless of the two-of-last-five-years requirement.
CALIFORNIA WITHHOLDING ON THE SALE OF REAL
PROPERTY
I. Introduction
This memorandum discusses the requirement under California
law that buyers withhold and transmit to the Franchise
Tax Board (FTB) funds equal to 3 1/3 percent of the
sales price of California real property unless an exemption
applies.
Effective January 1, 2005:
A buyer will be required to withhold 3 1/3 percent of
the gross sales price from both individuals (“natural
persons”) and non-individuals selling real property,
unless a certifiable exemption applies.
The certifiable exemptions include:
• the sale of property for less than $100,000,
• for individuals, the sale of a principal residence
or a property last used as a principal residence,
• the sale of a decedent’s principal residence
by a trust or estate,
• the sale of property by a corporation with a
permanent place of business in Calfiornia,
• an Internal Revenue Code (“IRC”)
§1031 exchange,
• an involuntary conversion under IRC §1033,
and
• sale of property at a loss for California income
tax purposes.
THE QUESTIONS AND ANSWERS THAT FOLLOW ARE BASED MAINLY
ON CALIFORNIA REVENUE AND TAXATION CODE (“REV.
& TAX CODE”) §§18662 AND 18668,
AS AMENDED BY AB 1388. THE QUESTIONS AND ANSWERS ARE
NECESSARILY GENERAL IN NATURE, AND ARE NOT INTENDED
TO COVER EVERY FACT SITUATION. SLIGHTLY DIFFERENT FACTS
MAY PRODUCE DIFFERENT RESULTS. ACCORDINGLY, CONSULT
A PROFESSIONAL TAX ADVISOR TO DETERMINE WHETHER (AND
HOW MUCH) WITHHOLDING IS REQUIRED IN A PARTICULAR TRANSACTION.
As used in this memorandum, "seller" means
any transferor, and "buyer" means any transferee,
unless specified differently in the California withholding
law.
II. CALIFORNIA RULE
A. THE "BASICS"
Q 1. When do the new withholding laws go into
effect?
A. The new withholding requirements go into effect on
January 1, 2005 and require withholding on any disposition
of real property that closes on or after that date unless
an exemption applies. Prior to January 1, 2005, withholding
is also required but the exemptions to withholding differ
depending on whether the seller is an individual or
a non-individual.
Q 2. What is required under the California
law for withholding on the sale of California real property?
A. Buyers must withhold 3 1/3 percent of the gross sales
price on sales of California real property interests,
unless an exemption applies.
Q 3. What sales are covered under this law?
A. The statute states that there must be withholding
on any disposition of a California real property interest
(Rev. & Tax Code §§18662(e)). This includes
sales, exchanges, installment sales, and other types
of transfers.
Q 4. What are the exemptions to this law?
A. After January 1, 2005, no withholding is required
when any one of the following exemptions applies:
FOR ALL SALES:
• The sales price of the property does not exceed
$100,000
• The buyer does not receive written notification
of the withholding requirement from the "real estate
escrow person”
• The property is acquired under a deed of trust
or mortgage through judicial or non-judicial foreclosure
or by a deed in lieu of foreclosure
• Sales by a bank acting as a trustee other than
under a deed of trust; or
• The seller is a partnership, LLC, tax exempt
entity, insurance company, IRA or qualified pension
plan.
FOR INDIVIDUALS AND CORPORATIONS WITH A PERMANENT
PLACF OF BUSINESS IN CALIFORNIA:
• The seller signs an affidavit under penalty
of perjury stating that the property is the seller's
principal residence within the meaning of IRC §121
(i.e. the seller has owned and used the property as
a principal residence for two out of the last five years);
or
• That the property was last used as the seller's
principal residence within the meaning of IRC §121
(this applies even though the seller may not have owned
and used the property as a principal residence for two
out of the last five years); or
• That the seller is a corporation with a permanent
place of business in California (a corporation does
not have a permanent place of business in California
if all of the following apply: (1) it is not a California
corporation, (2) it does not qualify with the California
Secretary of State to transact business in California,
and (3) it does not maintain and staff a permanent office
in California).
FOR ALL OTHER INDIVIDUALS, CORPORATIONS WITHOUT
A PERMANENT PLACE OF BUSINESS IN CALIFORNIA, AND TRUSTS
AND ESTATES:
• The seller signs an affidavit under penalty
of perjury stating that the property was the decedent’s
principal residence within the meaning of IRC §121;
or the sale is part of an IRC §1031 exchange (but
only to the extent of the amount of gain not required
to be recognized for California income tax purposes
under IRC §1031); or
• The property has been involuntarily or compulsorily
converted and the seller intends to acquire property
similar or related in service or use in order to be
eligible for nonrecognition of gain for California income
tax purposes under IRC §1033; or
• The transaction will result in a loss for California
income tax purposes.
(Rev. & Tax Code §§18662 and 18668)
Note that trustees of revocable or “living trusts”
are treated as “individuals” for purposes
of withholding. A buyer should retain a copy of the
seller’s affidavit for their records.
Q 5. Is withholding required when a partnership
or limited liability company (LLC) sells California
real property?
A. No withholding is required if the title to the real
property was recorded in the name of a partnership or
LLC. However, partnerships and LLC's are subject to
separate withholding requirements. See FTB Publication
1017 for more information on this subject. See Question
30 for how to obtain FTB publications.
Q 6. Is withholding required if there are one
or more owners/sellers meeting an exemption and other
owners/sellers who do not?
A. Yes. However, withholding is required only to the
extent of each seller’s interest in the property
if they are unable to qualify for an exemption.
Q 7. Is withholding required if the sale is
part of an exchange as defined under Internal Revenue
Code §1031?
A. As noted above, there is an exemption if the seller
signs an affidavit stating that the transaction is part
of a §1031 exchange.
Q 8. What are the withholding rules when a
relocation company participates in a sale?
A. Sales involving relocation companies are subject
to the same rules as other sales. (FTB Pub. 1016).
Q 9. Is withholding required on installment
sales?
A. Yes. However, withholding on the full sales price
can be deferred if the buyer agrees to withhold 3 1/3
percent of the down payment and each payment thereafter
(Rev. & Tax Code §18662).
Q 10. Is withholding required in a cash-poor
transaction such as a short sale, or when the buyer
puts little or no money down?
A. Yes. The fact that a transaction is cash-poor is
not an exception to withholding. If the property is
being sold at a loss, sellers can sign an affidavit
stating that the property is being sold at a loss.
Q 11. Is withholding required on a sale by
a California trust?
A. Yes unless an exemption applies. Perhaps the most
used exemption will be when the trustee signs an affidavit
certifying that the sale is of a decedent’s principal
residence within the meaning of IRC § 121.
Q 12. Is withholding required on a sale by
an estate?
A. No withholding is required if the executor/executrix
signs an affidavit certifying that the sale is of a
decedent’s principal residence within the meaning
of IRC § 121.
Q 13. Is withholding required when foreclosing?
A. Withholding is automatically waived if the property
is being acquired under a deed of trust or mortgage
through a judicial or non-judicial foreclosure or by
a deed of trust in lieu of foreclosure.
Q 14. Is withholding required on sales by tax
exempt entities, insurance companies or the Resolution
Trust Corporation (RTC) or other federal, state, or
local government agencies?
A. No. Under current FTB regulations, because these
sellers are exempt from income tax (insurance companies
are subject to a gross premiums tax and not income tax),
they are, accordingly, exempt from withholding. The
current FTB approach is that the buyer can rely on a
written statement from a tax-exempt entity or insurance
company. No statement is required from the RTC or other
governmental agency. It is anticipated that the FTB
will continue to recognize this exemption. (FTB Pub.
1016)
Q 15. Who is responsible for the withholding?
A. The buyer is responsible for withholding the required
amount. (Rev. & Tax Code §§18662) This
is typically accomplished through a written instruction
to escrow. If there are two or more buyers, each is
obligated to withhold. However, the obligation of all
of the buyers will be met as long as at least one of
them withholds and transmits to the FTB the required
amount. (FTB Pub. 1016)
Q 16. Who is responsible for notifying the
buyer of the withholding requirement?
A. It is the responsibility of the “real estate
escrow person” to notify the buyer in writing
of the withholding requirement. (Rev. & Tax Code
§§18662(e))
Q 17. Who is a "real estate escrow person"?
A. A real estate escrow person is any of the following
persons involved in a real estate transaction in the
following order of priority:
The person responsible for closing the transaction (typically
an escrow company, title company, or attorney),
Any other person who receives and disburses the funds
paid or other consideration or value given for the property
conveyed. (Rev. & Tax Code §§18662(e)(6))
B. WITHHOLDING WAIVER
Q 18. Can the seller request a reduced amount
(or no amount) of withholding?
A. Effective January 1, 2005, sellers can no longer
request that the FTB authorize a reduced amount of withholding.
However, both individuals and non-individuals can certify
that they meet one of the applicable exemptions.
C. HANDLING OF FUNDS AND REPORTING
Q 19. When must the required amount of withheld
funds be sent to the FTB?
A. The required amount withheld must be remitted to
the FTB within 20 days following the end of the month
in which the transaction closes. (FTB Pub. 1016) For
example: If title transfers to the buyer on March 15,
2005, the buyer must remit the required amount and form
to the FTB by April 20, 2005. Again, the parties should
usually instruct the escrow holder to perform this function.
Q 20. How are withheld amounts reported and
transmitted?
A. They are reported and transmitted on California tax
form 597. See Question 30 for how to obtain California
tax forms. The form and the withheld amount should be
sent to:
Franchise Tax Board
P.O. Box 942867
Sacramento, California 94267-0001
In addition, if there are multiple sellers, the applicable
form must be filed for each person subject to withholding.
NOTE: Currently, Copy B of California Form 597 must
be attached to the face of the seller's tax return,
so that the withheld amount will be credited against
the seller's FTB tax obligations. (FTB Pub. 1016)
D. FEE
Q 21. Can escrow companies charge a fee for
this service?
A. Escrow may not charge a fee to notify the buyer of
the withholding requirement. Escrow may charge a fee
only if it withholds and remits money to the FTB or
assists the parties in dealing with the FTB. In this
instance, the fee may not exceed $45.00. (Rev. &
Tax Code §§18662(e)(7)(D))
E. POTENTIAL LIABILITY
Q 22. What is the potential liability of the
buyer for failure to withhold the required amount when
given written notification of the withholding requirement
by the escrow holder?
A. The FTB can assess the buyer the full 3 1/3 percent
of the sales price that should have been withheld, or
the seller's actual tax liability in the sale, not in
excess of 3 1/3 percent, whichever is greater, unless
the failure to withhold is due to reasonable cause.
Even if the seller eventually pays the taxes due on
the sale, the buyer can still be held liable for a penalty
for failing to withhold as required. This penalty is
the greater of:
$500.00, or
10 percent of the amount required to be withheld, plus
interest and collection costs. (Rev. & Tax Code
§18668(d))
Q 23. Are there any exemptions to the penalty
mentioned above?
A. Yes, there are two exemptions. The buyer is not liable
if the failure to withhold was either:
? the result of the real estate escrow holder's reliance
upon the seller's affidavit as long as the reliance
was in good faith and based on all the facts known to
the escrow holder (Rev. & Tax Code §18668(e)(4));
or
? due to "reasonable cause." (Rev. & Tax
Code §18668(d))
Q 24. What is the potential liability of the
escrow holder for failure to notify the buyer of the
withholding requirements?
A. When a California real property disposition is subject
to withholding, failure of the escrow holder to give
written notification of the withholding requirements
subjects the escrow holder to a penalty of:
$500.00, or
10 percent of the amount required to be withheld, whichever
is greater, unless the failure to notify is due to reasonable
cause. (Rev. & Tax Code §18668(d)(1))
Q 25. Are there any situations in which the
escrow holder is excused from the penalty mentioned
above?
A. Yes, the escrow holder is excused from the penalty
if:
? the seller actually pays the tax due on the transfer;
? the failure to notify is based on "reasonable
cause"; or
? the escrow holder relies on the seller's affidavit
as long as the reliance is in good faith and based on
all the facts known to the escrow holder.
(Rev. & Tax Code §§18668(e))
Q 26. Is there any liability for a seller under
this law?
A. Yes. Any seller who knowingly files a false affidavit
is liable for the greater of:
$1,000, or
20 percent of the amount required to be withheld. (Rev.
& Tax Code 18668(e)(5))
F. SELLER'S AFFIDAVIT
Q 27. What is the seller's affidavit?
A. The seller's affidavit is a document used to obtain
an exemption from withholding. In it, the seller certifies,
under penalty of perjury, that he/she/it meets one of
the withholding exemptions listed in Question 4. If
the seller completes the California portion of that
form and signs it, the buyer can rely on it without
fear of any liability for not withholding, unless the
buyer knows that information in the affidavit is false.
(Rev. & Tax Code §18668(e))
Q 28. Must the seller's affidavit be signed
before a notary public?
A. No.
G. THE PURCHASE CONTRACT
Q 29. What provision should be made in the sales
agreement for compliance with this law?
A. The deposit receipt or other sales agreement should
reflect the agreement of the buyer and seller to comply
with the requirements of this law by either having the
proper amount of tax withheld and deducted through escrow,
or obtaining and providing appropriate documentation
that no withholding, or reduced withholding, is required.
C.A.R.'s California Residential Purchase Agreement and
Joint Escrow Instructions (RPA-CA) covers compliance
with this law under the paragraph entitled "Withholding
Taxes." Parties to transactions who use other contract
forms should include an appropriate provision in each
agreement.
H. CALIFORNIA TAX FORMS AND PUBLICATIONS
Q 30. Where can I obtain the California tax
forms and publications referred to in this legal memorandum?
A. You can get California tax forms and publications
in several ways:
1) Through the FTB’s website at http://www.ftb.ca.gov/.
2) By mail at Tax Forms Request Unit, Franchise Tax
Board, P.O. Box 302, Rancho Cordova, CA 95741-0307.
3) By telephone from the FTB’s Withholding Section
at 800.792.4900 or 916.845.4900.
4) By fax at the FTB’s Forms by Fax at 800.998.3676.
I. ADDITIONAL INFORMATION
Q 31. Where can I obtain additional information?
A. Principals should consult their own professional
tax advisors for advice in particular transactions.
In addition, the FTB has set up a special unit to deal
with this law. You may contact this unit by telephone
at 916.845.4900, by fax at 916.845.4831, through the
FTB’s website at www.ftb.ca.gov, or write to
Franchise Tax Board
Withholding at Source Unit
P.O. Box 651
Sacramento, CA 95812-0651
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