Updated May 5, 2014
FOREIGNERS AND THEIR PROPERTY INVESTMENTS
(Part 2 – State of California Real Estate Withholding under the Revenue and Taxation Code)
The State regulations regarding withholdings on real property sales is a little different from the Federal withholding as mentioned in Part 1 – withholding under the FIRPTA guidelines. For the State, the law is written such that all real property being sold requires the payment of tax in an amount equal to 3.33% of the sales price. The amount is withheld from the Seller right in the escrow transaction and sent to the Franchise Tax Board at closing. The amount is considered a “prepayment” of income taxes on the potential gain. There are, however, certain withholding exemptions and those can be found on California’s 593-C Real Estate Withholding Certificate.
EXEMPTIONS that can be claimed:
1) If the sales price is $100,000.00 or less (exemption is automatic).
2) The Seller has used the property as his principal residence at least 2 out of the 5 year period right before the sale.
3) The Seller is a California corporation, limited liability company or partnership that is NOT a single member entity and which is registered to do business in California.
4) The Seller can claim a loss or zero gain on the sale by filling out form 593-E (Computation of Estimated Gain or Loss).
5) 1031 Tax Deferred Exchange transactions: If the Seller is doing a 1031 tax deferred exchange with the property, then he can check one of the boxes on the 593-C form. However, if he does not conclude the exchange or only part of the funds are used, then the withholding will still need to be done.
6) Installment Sale transactions: A different animal! This “exemption” is different. If the Seller is carrying a loan for the Buyer then the part of funds that he receives at the close of escrow- Sales price minus installment Note – (which is called the “first installment by the FTB) will require the withholding AND every time the Buyer pays the principal on this loan, he will have to do the withholding on the principal paid and send that amount to the State. The Buyer must complete and sign form 593-I (Real Estate Withholding Installment Sale Acknowledgement) at close of escrow.
If the parties decide NOT to continue with the withholding after close of escrow, the Seller can declare the full sale amount on his next tax return, and then send a written request to the FTB to release the Buyer from withholding on the installment sale payments.
Please note: The FTB WILL NOT take a full 3.33% payment on the full sales price at the time of closing, even if both parties want it. FTB will reject the payment and ask the Seller and Buyer to pay per their regulations.
The above exemptions, with the exception of the 1st one, are not automatic. Your Settlement Agent will be providing the Franchise Tax Board form 593-C (Real Estate Withholding Certificate) to be reviewed, completed and signed. If the Seller can check any one of the boxes on the form, then the transaction is exempt.
Can I submit a lower tax amount? The standard withholding is 3.33% of the sales price. However, the State will allow Sellers to calculate and submit 12.3% on the gain amount for an individual or 13.8% for a corporation. In order to withhold on this lesser rate the Seller will use form 593-E (Computation of Estimated Gain or Loss) to calculate the amount to withhold, and then select the appropriate box 4B-G and certify Form 593 (Withholding Tax Statement) and hand this Form 593 to the Settlement Agent.
Do I need a Tax ID number? One of the important aspects of the 593-C form is that if the Seller is able to check one of the boxes on the form, but is not able to provide a Social Security Number or Individual Tax Identification Number (ITIN), then the form itself is void and the full withholding and payment of the 3.33% tax is automatically required. This means that a foreigner who uses the property as his principal residence MUST have a ITIN number in order to qualify for the exemption.
This can be obtained by submitting form W-7 (http://www.irs.gov/pub/irs-pdf/fw7.pdf to the IRS (see instructions – http://www.irs.gov/instructions/iw7/ch01.html#d0e465). We will require this TIN number by the time we close escrow and as it takes 6ñ8 weeks to process.
How do I get my money back? The tax amount must be sent to the state within 20 days from the end of the month in which the transaction closed. The amount sent to the Franchise Tax Board is a ìprepaymentî of income tax due on the gain. To get the money back the Seller must file their income tax return at the end of the fiscal year and include a copy of the 593 form. If the funds sent to the Franchise Tax Board are more than the tax liability for that year, the FTB will refund the difference.
Whose responsibility is it to make sure the law is followed? Unlike the Federal (FIRPTA) laws, the responsibility for obtaining the signatures on the correct State withholding forms and sending the amounts to the FTB fall on the Settlement Agent handling the sale. It is the Seller’s responsibility to complete the forms correctly and seek independent financial and legal counsel. As the forms state, title and escrow persons, exchange accommodators are not authorized to provide legal or accounting advice on the withholding amounts.
Audits! Yes! The Franchise Tax Board does audit Settlement Companies to make sure that the regulations are followed.
For further questions regarding the State of Californiaís Real Estate Withholding laws, you can click on the following links:
For Withholding requirements: https://www.ftb.ca.gov/individuals/wsc/California_Real_Estate.shtml
For all the various forms mentioned above, go to:
Please note that State regulations can be changed from year to year and it is important to review the most up to date information on the FTB website.
We hope this article has been of interest to you. Please leave us a comment or a general question on our website, www.vivaescrow.com. If you are interested in the federal Foreign Investment in Real Property Act (FIRPTA) which is Part 1 of this series, please look for that on our site too.