In the recent state legislative session there was a little-noticed bill (AB 2962 - Benoit) that contained good news for sellers of investment property in California. In many cases this new law will result in reduced withholding when the property is sold.
Existing law provides that most persons selling California property that is not their personal residence must withhold 3 1/3 percent of the gross sale price. There is a variety of special exceptions to this -- too numerous to detail here -- but they are of little consequence to most individuals. Also, technically, it is the buyer who withholds the funds, but they always come out of the proceeds due the seller.
Until 2003 withholding was only required when a seller lived out of state. As part of the 2002-03 budget, the Legislature extended the withholding requirements to state residents as well. As the Senate bill analysis frankly puts it, that change was "enacted to generate cash flow for the state during a time of fiscal crisis."
The problem, according to both the bill's author and the legislative analysts, has been twofold. First, it "resulted in many taxpayers being over-withheld, because 3 1/3 percent of the gross sales price of the property often exceeds the amount of tax due … ." Secondly, "the resulting overwithholding of state income tax is not only an inconvenience to the taxpayer but can result in an alternative minimum tax liability at the federal level." (Don't even think of asking me to explain how that works, because I don't know.)
Under AB 2962, withholding requirements still apply to the same people; but there is now an alternative to the 3 1/3 percent of gross sales price amount. Now, taxpayers can calculate the gain and pay tax on that amount instead. The alternative amount to be withheld is the maximum tax rate (9.3 percent) of the taxable gain.
In many cases, that could be very good news. Suppose you had purchased an investment property a few years back -- when everything was guaranteed to appreciate at 27 percent -- for $600,000; but in 2007 you are happy to be able to sell it for $650,000. Assuming that $600,000 is your basis, with selling costs of $15,000 you would be looking at a taxable gain of $35,000. Under today's tax laws, you would have to withhold 3 1/3 percent of the gross sales price -- $21,645. But the alternative provided by AB 2962 will allow you to withhold on the basis of 9.3 percent of the taxable gain. In this case, that would mean withholding $3,255. Which would you prefer?
Of course, choosing this alternative will not always be preferable. Suppose you had purchased the property a long time ago for around $200,000 and that you had a taxable gain of $400,000. Using the new alternative, you would have to withhold $37,200. Maybe you would want to stick with the former method of computing the withholding.
In applicable transactions, withholding is still required. But, effective Jan. 1, 2007, the taxpayer may choose by which method to calculate the withholding amount. If the new alternative is used, he must certify his calculation, under penalty of perjury. The relevant forms, as well as worksheets, will be available on the Franchise Tax Board (FTB) website.
The FTB estimated that the fiscal impact of this bill will be to reduce cash flow to the state by about $70 million in the 2006 - 07 fiscal year, and by only $5 million in each of the subsequent two. It was noted that "this bill does not affect ultimate tax liabilities, only the timing of payments."
AB 2962 sailed through both houses with no opposition. Supporters included the California Association of Realtors® and the Howard Jarvis Taxpayers Association. It was signed by the Governor on September 22.
