I.
Introduction
This memorandum
discusses the requirement under California law that a
buyer 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.
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
foreign person (a non-resident for California tax
purposes). However, 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 Questions and
Answers that follow are based mainly on California
Revenue and Taxation Code (“Rev. & Tax Code”)
§§18662 and 18668, as amended by AB 2065. 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, parties should 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
Q 1.
When do the new withholding laws go into
effect?
A. The new withholding
requirements go into effect on January 1, 2003 and
require withholding on any disposition of real property
on or after that date unless an exemption applies.
C.A.R. is working with the Franchise Tax Board (FTB) to
clarify whether the “disposition” of the property is the
date that the contract was entered into or the date of
closing. At the time this Q&A is being prepared it
is the FTB’s position that the new withholding
requirements will apply to all transactions closing on
or after January 1, 2003.
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, 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))
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) and (f)). This includes sales, exchanges,
foreclosures, installment sales, and other types of
transfers.
Q
4. Are there any exemptions to this
law?
A. Yes, but the exemptions
differ depending on whether or not the seller is an
individual (“natural person”).
Q
5. What are the exemptions when the seller of
California real property is an
individual?
A. 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. (C.A.R.
Standard Form AS January 2003 version* or
California tax form 593-C satisfies this affidavit
requirement. See Question 35 for
how to obtain California tax forms.); 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) (C.A.R. Standard Form AS, January 2003
version* or 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 (C.A.R. Standard
Form AS, January 2003 version* or
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 (C.A.R. Standard Form AS, January
2003 version* or 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." (See
Questions 19 and 20); 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.
* The June 2002 or the
October 2002 form AS should be used for
transactions prior to January 1, 2003.
Q 6.
What are the exemptions when the seller of California
real property is a not an
individual?
A. 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. (See Question 21.) (Rev. & Tax Code
§§18662(f)(2), (3) and (4) and FTB Publication 673)
However, the seller
must sign C.A.R. Standard Form AS or 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.
Q 7.
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 35 for
how to obtain FTB publications.
Q 8.
Is withholding required if the owners/sellers are not
individuals and one or more owners/sellers has a last
known address outside California and the other
owners/sellers have addresses within
California?
A. Yes. Withholding is
required on the total sales price if any owner/seller is
not an individual and has a last known address outside
of California, unless some other exemption
applies.
Q 9.
Is withholding required if the sale is part of an
exchange as defined under Internal Revenue Code
§1031?
A. It depends on whether the
seller is an individual. For individual sellers there is
an exemption if the seller signs an affidavit stating
that the transaction is part of a §1031 exchange. For
transfers by other sellers, a §1031 exchange by a seller
with a last know address out side of California is
subject to the withholding requirements, unless the
transaction meets one of the exemptions from
withholding. (See Question 6.) Sellers who are not
individuals can request a withholding waiver from the
FTB. (See Question 21.)
Q
10. 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. (Current FTB Pub. 1016)
Q
11. Is withholding required on installment
sales?
A. Yes. However, for
individual sellers, 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(e)(3)). For other sellers,
withholding is required on the total sales price even
though payments will be made in installments. The buyer
would use California tax form 593-I. Sellers who are not
individuals can request a waiver from the
FTB.
Q
12. 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. However, a seller who is not an individual
can request a waiver if the transaction involves a
situation in which the FTB would allow a waiver or
reduced withholding. If a waiver is not granted or the
funds in escrow will not cover an authorized reduced
withholding, the parties must arrange to pay the
withholding. If the property is being sold at a loss,
sellers who are individuals can sign an affidavit
stating that the property is being sold at a loss. (See
Question 5.)
Q
13. Is withholding required on a sale by a
California trust?
A. No withholding is
required as long as the trust is irrevocable, at least
one trustee is a California resident and an affidavit is
signed attesting to this fact. However, if the trust is
a grantor or revocable trust, the grantor is treated as
an individual seller of real estate. If there are
multiple grantors and any one grantor does not meet an
exemption requirement, withholding is required. If all
of the grantors meet an exemption, no withholding is
required once an affidavit attesting to this fact is
signed. (Current FTB Pub. 1016)
Q
14. Is withholding required on a sale by an
estate?
A. No withholding is
required if the decedent was a California resident at
the date of death and the executor signs an affidavit
attesting to this fact.
Q
15. Is withholding required when
foreclosing?
A. Withholding is
automatically waived if the property is being acquired
in a foreclosure by a corporate beneficiary. (See
Questions 5 and 6.) If the property is being acquired in
a foreclosure by anyone other than a corporate
beneficiary, a waiver must be requested before the
withholding can be waived.
Q
16. 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. (Current FTB Pub.
1016)
Q
17. What is a "financial
intermediary"?
A. It is an agent who
receives and transfers funds on behalf of a principal.
(Rev. & Tax Code §18662(f)(7)) A financial
intermediary may be an individual, a corporation, or
other business entity, and may be located within or
outside of California.
Q
18. Who is responsible for the
withholding?
A. The buyer is responsible
for withholding the required amount. (Rev. & Tax
Code §§18662(e) and (f)) 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. (Current FTB Pub.
1016)
Q
19. 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)(2)(B) and
(f)(3)(B))
Q
20. 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) and
(f)(8))
B.
Withholding Certificate/Waiver
Q
21. How can the seller request a reduced amount
(or no amount) of withholding?
A. Sellers who are not
individuals can request the FTB to authorize a reduced
amount of withholding, or none, by filling out and
sending to the FTB the appropriate form. See Question 35
for how to obtain California tax forms. Note, however,
that this procedure is only available to sellers other
than individuals (Rev. & Tax Code §18662(f)(4)).
There is no similar provision in the section of the law
providing exemptions from withholding for individual
sellers.
The FTB will then
determine the actual gain to be recognized on the
transaction. Based on the information contained in the
appropriate form, the FTB may then authorize a reduced
amount of withholding substantially equal to the amount
of tax estimated to be due, or may exempt the transfer
from withholding altogether.
Sellers may wish to
fax their request to expedite matters. If a request is
sent by fax, the seller should not mail the original as
it may cause duplicate work on the same request. FTB's
fax number is 916.845.4831.
Q
22. How long does the FTB have to answer the
seller's request?
A. The FTB has 45 days after
receiving the seller's request to authorize a reduced
amount, or none, or to deny the request. (Rev. & Tax
Code §18662(f)(4)(B))
C. Handling Of
Funds And Reporting
Q
23. What happens if escrow closes prior to the
FTB's response to the seller's request for no or reduced
withholding?
A. The parties may instruct
escrow to hold the required amount in trust for 45 days
after the title transfers. At the end of 45 days the
amount withheld must be sent to the FTB unless the FTB
has waived withholding or authorized a reduced
withholding amount. (Rev. & Tax Code
§18662(f)(4)(C))
Q
24. 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. (Current FTB Pub. 1016) For example: If title
transfers to the buyer on March 15, 2003, the buyer must
remit the required amount and form to the FTB by April
20, 2003. Again, the parties should usually instruct the
escrow holder to perform this
function.
Q
25. How are withheld amounts reported and
transmitted?
A. They are reported and
transmitted on California tax form 597. See Question 35
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. (Current FTB Pub. 1016)
D.
Fee
Q
26. 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) and
(f)(9))
E. Potential
Liability
Q
27. 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)(7))
Q
28. 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 (described in Question 31) 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
29. 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(e)(1))
Q
30. 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 (described in
Question 31), 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)(4))
Q
31. 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
32. 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 meets one of the withholding exemptions
listed in Question 5 and 6. (After January 1, 2003, the
seller can use C.A.R. Standard Form AS, January 2003
version or the applicable FTB form for this
purpose.) 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)(4))
Q
33. Must the seller's affidavit be signed before a
notary public?
A. No.
G. The
Purchase Contract
Q
34. 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
35. Where can I obtain the California tax forms
and publications referred to in this
Q&A?
A. You can get California
tax forms and publications in several
ways:
1) Through the FTB’s
website at 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.
Note, however, that at
the time of writing this Q&A, the FTB has not
produced forms or publications implementing the
amendments to the withholding law. The FTB anticipates
that they will have forms available at the beginning of
December.
I. Additional
Information
Q
36. Where can additional information be
obtained?
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.
This memorandum is
just one of the many legal publications and services
offered by C.A.R. to its members. For a complete listing
of C.A.R.’s legal products and services, please visit
C.A.R. Online at www.car.org.
Readers who require
specific advice should consult an attorney. C.A.R.
members requiring legal assistance may contact C.A.R.’s
Member Legal Hotline at 213.739.8282, Monday through
Friday, 9:00 A.M. to 6:00 P.M. C.A.R. members who are
broker-owners, office managers, Designated REALTORS® or
subscribers of C.A.R.’s Risk Management Program may
contact the Member Legal Hotline at 213.739.8350 to
receive expedited service. Members may also fax or
e-mail inquiries to the Member Legal Hotline at
213.480.7724 or legal_hotline@car.org.
Written correspondence
should be addressed to:
California Association
of REALTORS®
Member Legal Services
525 South
Virgil Avenue
Los Angeles, California
90020
The information
contained herein is believed accurate as of October 16,
2002. It is intended to provide general answers to
general questions and is not intended as a substitute
for individual legal advice. Advice in specific
situations may differ depending upon a wide variety of
factors. Therefore, readers with specific legal
questions should seek the advice of an attorney.
