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.
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Joanne L. Gardiner, your San
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