(State of California Real Estate Withholding
under the Revenue and Taxation Code Section 18662)
Are you an individual who is looking to sell a property in California?
There are no restrictions for you to buy, but when it comes time to sell, you will need to plan in advance because the State of California has some laws that may apply to you, whether you are a foreigner, an individual living out-of-state, or an individual investor.
Knowing about the laws and planning in advance will save you much time, effort and headaches when the time comes.
This article is written as an educational tool for other Escrow Officers (Settlement Agents) and for Real Estate Agents, but as an Investor, it is definitely to your advantage to see what you need to know when you are going to sell that property located in California.
The State regulations regarding withholdings on real property sales is a little different from the Federal withholding of foreigners under the FIRPTA guidelines.
For the State, the law is written such that all real property being sold requires the payment of tax at the close of escrow in an amount equal to 3.33% of the Sales Price.
The amount is withheld by the Settlement Agent from the Seller’s account at the closing of the transaction and sent to the Franchise Tax Board (FTB).
The amount is considered a “prepayment” of income taxes on the potential gain.
The withholding applies to all Sellers, whether they are U.S. citizens, permanent residents with green card, foreigners, individuals who live out-of-state, or individuals who live in the State.
This article is presented to delineate the certain exemptions that can be used to bypass the regulation.
The full list of exemptions can be found on the 593-C Real Estate Withholding Certificate. You can go on Franchise Tax Board (FTB) site and type in 593-C and get the latest version.
The form changes every year. Here we will talk about some of the most common ones that the Settlement Agent works with on a daily basis:
- If the sales price is $100,000.00 or less, the exemption is automatic, no form needs to be completed
- The Seller has owned and used the property as his principal residence at least 2 out of the 5 year period right before the sale
- The Seller is a California corporation, limited liability company or partnership that is NOT a single member entity (the ownership is one sole individual) and which is registered to do business in California
- The Seller can claim a loss or zero gain on the sale by filling out form 593-E (Computation of Estimated Gain or Loss)
- 1031 Tax Deferred Exchange transactions: If the Seller will be replacing the property, which is declared to be an income property for his tax purposes, by purchasing a new one immediately or soon after, then this can be done under an IRS 1031 tax deferred exchange regulations. In this case he can check one of the boxes on the 593-C form to claim exemption. However, if he does not conclude the exchange or if only part of the funds are used, then the withholding will still need to be done on the amount not used.
- Installment Sale transactions: When the Seller is lending part of his net proceeds as a loan to the Buyer, the transaction becomes an “installment sale”. This means that the Seller is not getting all his money at the close of escrow, but will get it in installment payments form. This “exemption” is different. The part of funds that the Seller does receive at close of escrow– Sales Price minus the Installment Note amount – will require the withholding. The FTB calls this the “first installment”. Every time the Buyer pays down the principal on this loan, he will have to do the 3.33% withholding on the principal paid and send that amount to the FTB.
Settlement Agent: Please be sure that the Buyer completes and signs form 593-I (Real Estate Withholding Installment Sale Acknowledgement) at close of escrow.
Please note: If the parties decide NOT to continue with the withholding after close of escrow, the Seller must declare the full Sales Price on his next tax return, pay the balance of the 3.33%, 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 the 3.33% payment on the full Sales Price at the time of closing, even if both parties want to do so. FTB will reject the payment and ask the Seller and Buyer to pay per their regulations.
The exemptions, with the exception of the first one, are not automatic.
The Settlement Agent must provide Seller the 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, under penalty of perjury, then the transaction is exempt.
2. 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 8.84% or 13.8% for a corporation, depending on the type of corporation.
In order to withhold on this lesser rate the Seller must first use form 593-E (Computation of Estimated Gain or Loss) to calculate the amount of gain and then on form 593 (Withholding Tax Statement), select the appropriate box in 4B-G and put in the amount. Form 593 should be given to the Settlement Agent who will withhold this amount and send it to the State.
Please note: It is absolutely important that the Seller’s accountant is involved in completing the forms and figuring the calculation for withholding. After all, this accountant will be responsible for declaring the income tax at the end of the fiscal tax year for the Seller.
3. Do I need a Tax ID number?
Yes! One of the important aspects of the 593-C form is that even 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 an ITIN number in order to qualify for the exemption.
Settlement Agent will require this ITIN number by the time escrow is closing and as it takes 6–8 weeks to process, it is imperative that the process be started as soon as possible.
Recommendation: The foreign Seller should go to an accountant who is well versed in this area to apply for the ITIN. New regulations for the application of the ITIN requires the foreign applicant to submit their original passport with the application, or they must get a “Certified” copy of it. A “Certified” copy can only be obtained from special Certified Acceptance Agents at the IRS or elsewhere, and not all IRS locations have such a person.
Settlement Agent: If the ITIN has been applied for and is not back before the transaction closes, withhold on the full 3.33% and mark on the box in the 593 form that the Seller’s ITIN is “Applied For”. Once the ITIN comes in, send in an Amended 593 form for the Seller.
4. 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 “prepayment” of income tax due on the gain.
This means that 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 that the Settlement Agent provides at closing.
If the funds sent to the Franchise Tax Board are more than the tax liability for that year, the FTB will refund the difference.
5. Whose responsibility is it to make sure the law is followed?
Like the Federal FIRPTA laws, the responsibility for the withholding requirement falls on the Buyer. However, the Franchise Tax Board realizes that the Buyer may not know what to do so they put the responsibility on the Settlement Agent to obtain the signatures on the correct withholding forms and send the amounts to the FTB.
Settlement Agent: The Franchise Tax Board requires that the Settlement Agent gives proper written notification to the Buyer regarding this withholding regulation, and will require this notification to appear in the Escrow Instructions – “in accordance to Section 18662 of the Revenue and Taxation Code, a Buyer may be required to withhold an amount equal to 3 1/3% of the sales price….” It must also state how the exemptions can apply.
The language can be seen on FTB’s Publication 1016 which you can download from their website.
If the withholding is not done, or not done correctly, the Buyer may become liable for the tax and penalties.
This is a good reason why Buyers and Sellers must be sure that they are using a Settlement Agent who is knowledgeable and experienced in this law and who knows what needs to be done, what to expect, and what are possible solutions.
6. Whose responsibility is it to complete the forms?
It may be the Settlement Agent who provides the forms and does the withholding, but 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”.
7. Must Settlement Agents verify that the certificates are completed correctly?
If the Settlement Agent has actual knowledge that the form is not completed correctly, then the form must be rejected and returned to the Seller.
If Settlement Agent has no knowledge of the facts, then they can only verify that the certificates are completed and signed.
For instance, if Settlement Agent has no knowledge if the property is truly the principal residence, they can only receipt in what is given by the Seller.
However, if the Seller claims it is a partnership, but the title on the property clearly states that it is under individuals, then this is actual knowledge and Settlement Agents cannot accept a 593-C that is filled out incorrectly.
Please note: the 593-C form is completed under penalties of perjury. Perjury means to willfully make a false statement.
8. What if there are multiple Sellers in one transaction?
If the sales price in the transaction is less than $100,000, the first exemption still applies.
If the sales price in the transaction is more than $100,000, then each Seller would have to complete his own 593-C forms and show his ownership percentage.
If one of the Sellers does not actually own a percentage but is listed as a Seller for loan co-signing purposes, for instance, then he would mark “zero” as his ownership percentage on the 593-C and no withholding is required for that particular Seller. The withholding would fall on the other Sellers.
9. What if the property is partially a principal residence and partially income generating?
The Seller can claim the principal residence exemption only on the percentage allocated to the principal residence portion.
This means that two 593-C forms should be completed, one to be marked as his principal residence and the other marked as income property.
The proper percentage allocation needs be made on both forms.
10. What if there are multiple properties in one transaction?
If there are multiple properties being sold in one transaction and the total Sales Price for all the properties add up to less than $100,000, then the transaction is automatically exempt.
If it is more than $100,000, then withholding must be made unless other exemption categories in the 593-C form can be checked.
11. What about a Trust?
If the Trust is a Revocable Trust in which the Trustee is the original Trustor and Settlor of the Trust, if he has the right to cancel or revoke the Trust, and if the tax identification number used is his social security number, then this is a “Grantor Trust” and the FTB would treat it as if it were an individual.
If the Trust is an Irrevocable Trust in which the original Trustees have all passed away, and a Successor Trustee is handling the affairs of the trust, the Trust can no longer be revoked, and the tax identification number used is a new federal TIN, then this is a “Non-Grantor Trust”.
The FTB looks at this Trust as a separate entity of itself and not the original deceased Seller. This is important because the principal residence exemption might not apply.
Please note: In cases of a Non Grantor Trust, it is important that the Seller obtain his counsel from his accountant on how to complete the forms and whether he is exempt from withholding.
Yes, there are penalties. The penalty for a false certification by the Seller to avoid the withholding requirements is $1,000 or 20% of the required withholding amount, whichever is greater.
There are other penalties:
- Late filing
- Intentional disregarding the reporting requirements
- Failure to withhold
- Failure to remit the funds
- Failure to provide forms to the Seller
Please refer to FTB Publication 1016 for a concise list of penalties.
Yes! The Franchise Tax Board does audit Settlement Agents to make sure that the regulations are followed.
They will look at all the 593-C, 593-E, 593, 593-I, 593-V forms to make sure that the boxes were marked correctly, the forms completed correctly, including Seller’s names, forwarding address, the address of the property, the ITIN, and the ownership percentages.
Do you have further questions regarding the State of California’s Real Estate Withholding laws?
Here are the following links to the FTB website:
- For Withholding requirements go to Publication 1016
- To review all the various forms mentioned above, go to this Link
Please note: State regulations and forms 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 go to our website to look at all other articles that may be pertinent information to your transaction!
Remember, it is important that you choose a Settlement Agent who can bring his/her knowledge and experience to your transaction.