| 2005
TAX LAW CHANGES
CALIFORNIA WITHHOLDING ON THE SALE OF REAL
PROPERTY
I. INTRODUCTION
This 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
PLACE 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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