A new tax law in California may take many real estate professionals by surprise Jan. 1, when the method of real estate tax collection changes dramatically in California. If you’re planning on representing a client that owns rental property or a second home that is not their primary residence, like a vacation house or condo, make sure you understand the impact this new law will have on the transaction. Your clients may not have planned on factoring in paying 3 1/3 percent of the transaction value when they sell their property after the new year.

Currently this withholding requirement applies only to real estate sales by nonresidents. California's real property withholding law has generally followed the federal Foreign Investment In Real Property Tax Act (FIRPTA) focusing primarily on whether the seller is a nonresident of California.

The new law, "Sales and Use Tax" AB2065, written by Democrat Assemblywoman Jenny Oropeza of Long Beach and signed into law by Governor Davis, requires in-state buyers of California real estate to withhold 3 1/3 percent of the sales price and send it to the Franchise Tax Board. Previously, real estate sellers were responsible for paying the tax - 3 1/3 percent of net profits - by April 15 of the following year. After Jan. 1, however, buyers will be responsible for paying the tax, which now will be based on 3 1/3 percent of net proceeds, not of only the profits.

Not only will more taxes be paid under the new law but, because the tax must now be paid at escrow, the money will be in the government hands regardless of what’s owed come tax time. The State expects the change to affect 300,000 sales and accelerate tax revenue by $225 million. Although the speedier collection of taxes could help the state better balance its budget deficit, the law hasn't garnered many fans in the real estate community.

Procedurally, California escrow agents will provide notices of withholding requirements as well as instructions to be signed by the seller and the buyer, authorizing the remittance of the withheld amount to be sent to the Franchise Tax Board.

Effective January 1, 2003, AB 2065 amends California law in a significant manner

A buyer will be required to withhold 3 1/3 percent of the sales price from an individual (a "natural person") selling real property regardless of whether the seller is a California resident, unless an exemption applies.

The exemptions for individuals selling real property include the sale of property for less than $100,000, the sale of a principal residence, an Internal Revenue Code ("IRC") §1031 exchange, an involuntary conversion under IRC §1033, and the sale of property at a loss for California income tax purposes.

The rules for other sellers of real property (other legal persons, including irrevocable trusts, estates, corporations, limited liability companies and partnerships) remain focused on the seller’s residency.

The following highlights are based mainly on California Revenue and Taxation Code ("Rev. & Tax Code") §§18662 and 18668, as amended by AB 2065. Principals should consult their own professional tax advisors or attorneys for advice in particular transactions.

Buyers must withhold 3 1/3 percent of the gross sales price on sales of California real property interests, unless an exemption applies, when the seller is an individual (a "natural person") (Rev. & Tax Code §18662(e)(1)); or the seller is not an individual and the funds will be transferred to a seller with a last known street address outside of California or to the seller’s financial intermediary. (Rev. & Tax Code §18662(f)(1))

If the seller is a corporation, the buyer must withhold if the seller has no permanent place of business in California immediately after the transfer. (Rev. & Tax Code §18662(f)(2)) The statute states that there must be withholding on any disposition of a California real property interest (Rev. & Tax Code §§18662(e) and (f)). This includes sales, exchanges, foreclosures, installment sales, and other types of transfers. Exemptions differ depending on whether or not the seller is an individual ("natural person").

After January 1, 2003, no withholding is required when the seller is an individual and any one of the following exemptions applies:

• 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. California tax form 593-C satisfies this affidavit requirement; or
• The seller signs an affidavit under penalty of perjury stating that the property 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 (California tax form 593-C); or
• The seller signs an affidavit under penalty of perjury stating that 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 (California tax form 593-C); or The seller signs an affidavit under penalty of perjury stating that the transaction will result in a loss for California income tax purposes (California tax form 593-C); or
• The sales price of the property does not exceed $100,000; or
• The buyer does not receive written notification of the withholding requirement from the "real estate escrow person." or The property is acquired by a corporate beneficiary under a deed of trust or mortgage through judicial or nonjudicial foreclosure or by a deed in lieu of foreclosure. (Rev. & Tax Code §18662(e) and FTB Publication 673)

The buyer should retain a copy of the seller’s affidavit for their records.

For a seller that is not an individual, that is any other legal entity, such as a fiduciary (estate or irrevocable trust), limited liability company, corporation or exempt organization, no withholding is required if any of the following apply:

• The sales price of the property does not exceed $100,000; or The buyer does not receive written notification of the withholding requirement from the "real estate escrow person." (See Questions 19 and 20.); or
• The seller is a bank acting as trustee (other than under a deed of trust); or
• The property is acquired by a corporate beneficiary under a deed of trust or mortgage through judicial or nonjudicial foreclosure or by a deed in lieu of foreclosure; or
• The seller is a partnership, LLC, tax exempt entity, insurance company, IRA or qualified pension plan: or
• The seller is an irrevocable trust with a California trustee, or an estate with a California decedent; or
• The seller is a corporation and signs an affidavit under penalty of perjury stating that the corporation has 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 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); or
• The FTB authorizes a reduced amount of withholding or no withholding at all. (Rev. & Tax Code §§18662(f)(2), (3) and (4) and FTB Publication 673)

However, the seller must sign a California tax form 593-C under penalty of perjury certifying they are exempt from withholding. The buyer should retain a copy of the seller’s affidavit for their records.

You can get California tax forms and publications in several ways:

• Through the FTB’s website at www.ftb.ca.gov.
• By mail at Tax Forms Request Unit, Franchise Tax Board, P.O. Box 302, Rancho Cordova, CA 95741-0307.
• By telephone from the FTB’s Withholding Section at 800.792.4900 or 916.845.4900.
• By fax at the FTB’s Forms by Fax at 800.998.3676.
• 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 or write to

  Franchise Tax Board

  Withholding at Source Unit

  P.O. Box 651

  Sacramento, CA 95812-0651.

Saul Armian, is a California licensed real estate agent and marketing consultant with Armian Group LLC in San Francisco, CA. He can be reached at 415.293.7722 and saul@armiangroup.com. See www.armiangroup.com for more information.

Published: December 24, 2002

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