1 California Withholding Tax on the Sale of Real Property Member Legal Services Tel (213) Fax (213) Oct. 1, 2007 (revised) Table of Contents I. Introduction II. California Law A. The Basics B. Reduced Withholding C. Handling of Funds and Reporting D. Fee E. Potential Liability F. Seller's Affidavit G. The Purchase Contract H. California Tax Forms and Publications I. Additional Information I. Introduction This legal article discusses the requirement under California law that a buyer (or transferee) withhold and transmit to the Franchise Tax Board (FTB) funds equal to 3 1/3 percent of the sales price of California real property at the time of transfer of the property unless an exemption applies for the seller (or transferor). This article is based on California Revenue and Taxation Code Sections and (as amended by AB 1388 and AB 2969); the 2007 California FTB Forms 593-C, 593-E, instructions; and "Real Estate Withholding Guidelines," FTB Pub. 1016, rev The following 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 article, "seller" means any transferor, and "buyer" means any transferee, unless specified differently under the California withholding law. II. California Law A. The "Basics"
2 Q 1. What is a quick summary of California law for withholding on the sale of California real property and some exemptions? A Buyers must withhold 3 1/3 percent of the gross sales price on sales of California real property interests from both individuals (e.g., "natural" persons) and non-individuals (e.g., corporations, trusts, estates) and pay this amount to the Franchise Tax Board (FTB), unless an exemption applies (Cal. Rev. & Tax Code 18662(e)(1)(A), (B), (2)(A)). Escrowholders must give buyers written notice of these withholding requirements. If the escrowholder fails to give the buyer this written notice, then the buyer is off the hook for the withholding tax liability. ( (Cal. Rev. & Tax Code 18662(e)(3)(B).) Typically, the escrowholder submits both the form and money withheld to the FTB. The exemptions include:. the sale of property for less than $100,000 (Cal. Rev. & Tax Code 18662(e)(3)(A));. for individuals, the sale of a principal residence or a property last used as a principal residence (Cal. Rev. & Tax Code 18662(e)(3)(D)(i));. the sale of a decedent's principal residence by the estate (Cal. Rev. & Tax Code 18662(e)(3)(D)(i));. the sale of property by a corporation with a permanent place of business in California (Cal. Rev. & Tax Code 18662(e)(3)(D)(v));. an Internal Revenue Code (IRC) 1031 exchange (without any recognized gain)(cal. Rev. & Tax Code 18662(e)(3)(D)(ii));. an involuntary conversion under IRC 1033 (Cal. Rev. & Tax Code 18662(e)(3)(D)(iii));. the sale of property at a net loss (or a net gain not required to be recognized) for California income tax purposes (Cal. Rev. & Tax Code 18662(e)(3)(D)(iv));. seller's tax liability, calculated at the maximum rate regardless of seller's actual rate, will be less than 3 1/3% and seller certifies that fact under penalty of perjury. (For tax rate for corporations, see Cal. Rev. & Tax Code or 23186; for maximum tax rate for other sellers, see Cal. Rev. & Tax Code ) (Cal. Rev. & Tax Code 18662(e)(2)(B).) Q 2. What sales are covered under this law? A California law states that there must be withholding on "any disposition of a California real property interest" (Cal. Rev. & Tax Code 18662(e)). This includes sales, exchanges, installment sales, and other types of transfers.
3 Q 3. What are the exemptions to this law? A No withholding (or a reduced withholding) is required when any one of the following exemptions applies. NO WITHHOLDING AT THE TIME OF SALE (TRANSFER) FOR THE FOLLOWING:. The sales price of the property is equal to or less than $100,000 (Cal. Rev. & Tax Code 18662(e)(3)(A)).. The buyer does not receive written notification of the withholding requirement from the "real estate escrow person. (This exemption does not apply to a 1031 exchange accommodator.) (Cal. Rev. & Tax Code 18662(e)(3)(B).). The property is the seller's principal residence within the meaning of IRC 121 (i.e., the seller has owned and used the property as a principal residence for two out of the last five years) (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D(i)(I).). The property was last used as the seller's principal residence within the meaning of IRC 121. (This exemption applies even though the seller may not have owned and used the property as a principal residence for two out of the last five years.) (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D(i)(II).). The seller is a corporation with 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 not 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) (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D)(v)).. The property was the decedent's principal residence within the meaning of IRC 121. (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D(i)(I).). The property has been involuntarily or compulsorily converted (e.g., seized, destroyed, or condemned) 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 (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D(iii).)
4 . The property is acquired under a deed of trust or mortgage through judicial or nonjudicial foreclosure or by a deed in lieu of foreclosure (Cal. Rev. & Tax Code 18662(e)(3)(C)(i)).. The seller is a bank acting as a trustee other than under a deed of trust (Cal. Rev. & Tax Code 18662(e)(3)(C)(ii)).. The seller is a partnership. (However, partnerships must still withhold on nonresident partners.) (2007 Cal. FTB Forms 593-C, 593-E, and Instructions; FTB Pub ). The seller is an LLC classified as a partnership for federal and California income tax purposes and is not a single member LLC. (However, LLCs must still withhold on nonresident members. For single member LLCs, the single member is considered the seller. If the member is an individual, complete the withholding exemption form as an individual. If the member is a corporation, complete the form as that corporation, etc.) (2007 Cal. FTB Forms 593-C, 593-E, and Instructions; FTB Pub. 1016; FTB Pub ). The seller is an tax-exempt entity, insurance company, IRA, qualified pension plan, or charitable remainder trust. (2007 Cal. FTB Forms 593-C, 593-E, and Instructions; FTB Pub ). The transaction will result in a net loss or net gain not recognized for California income tax purposes (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D(iv).) PARTIAL OR FULL WITHHOLDING EXEMPTION:. The sale is part of an IRC 1031 exchange (reduced or partial withholding to the extent of the amount of gain not required to be recognized for California income tax purposes under IRC 1031). (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(D)(ii)(I).). The sale is an installment sale that seller will report as such and buyer has agreed to withhold 3 1/3% of each principal payment instead of withholding the full amount at time of transfer. (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(3)(E).). Alternative Withholding Amount: As a result of the sale, the seller's tax liability, calculated at the maximum tax rate regardless of seller's actual tax rate will be less than the 3 1/3% withholding otherwise required. (For this exemption, the buyer must withhold unless she/he relies in good faith on a written certificate signed by the seller certifying the information under penalty of perjury.) (Cal. Rev. & Tax Code 18662(e)(2)(B), (C).) (For tax rate for corporations, see Cal. Rev. & Tax Code or 23186; for maximum tax rate for other sellers, see Cal. Rev. & Tax Code )
5 Q 4. Can sellers refuse to provide their social security number or tax identification number on the written certification for withholding exemption purposes? A According to the FTB, "if the seller does not have or does not provide a tax ID number on Form 593-B, 593-C, or 593-E, then. The seller does not qualify for an exemption,. Any certification of an exemption is void, and. The escrow officer should withhold 3 1/3 percent of the total sales price." However, the seller's tax ID number can be removed only from the buyer's copy, not from other copies by the escrowholder. (NOTE: THIS IS THE FTB POLICY ONLY AND NOT THE IRS POLICY. ) (Source: (Questions 5 and 6)) Because the IRS does not allow for the tax ID to be marked out from the buyer s copy, buyers should therefore retain a copy of the fully completed seller s affidavit for their records including the seller's social security or tax identification number. C.A.R. form AS (Seller's Affidavit of Nonforeign Status) incorporates the text of FTB form 593-C for the California withholding portion. The two common exemptions under federal law from the requirement of providing a seller s affidavit to the buyer with the seller s social security or tax identification are 1) when the buyer qualifies under the Buyer s Affidavit (CAR Form AB) or 2) when a qualified substitute can be used (CAR Form QS). See questions 3, 8 and 20 on our Q&A Federal Withholding: The Foreign Investment in Real Property Tax Act (FIRPTA). Q 5. Is withholding required when a partnership or limited liability company (LLC) sells Californiareal property? A No withholding is required if the title to the real property was recorded in the name of a partnership or a non-single member LLC classified as a partnership for federal and California income tax purposes. However, partnerships must withhold on nonresident partners and LLCs must withhold on nonresident members. In addition, if the LLC is a single-member LLC that is disregarded for federal and California income tax purposes, then that single member is considered the seller and the one on title for withholding purposes. That member completes the withholding exemption certificate form as that individual (or corporation). When the C.A.R. form AS (or FTB form 593-C) is completed by the single member of the disregarded LLC, write on the bottom of the form that the information on the form is for the single member of the LLC so the escrow officer will understand why it is different from the recorded title holder. (Source: 2007 California FTB Forms 593-C, 593-E, instructions.) See FTB Publication 1017 for more information on this subject.
6 Q 6. Is withholding required if one or more owners/sellers meet an exemption and other owners/sellers do not? A Yes. The sellers satisfying the withholding exemption requirements would complete the withholding certificate. However, a pro-rata share of the withholding tax is required to be withheld but only to the extent of each seller s interest in the property who does not qualify for an exemption. Q 7. Is withholding required if the seller is a revocable trust? A Yes, unless one of the exemptions in Question 3 applies. For withholding tax purposes, the revocable trust is transparent and the individual seller (the grantor(s) of the trust) must report the sale and claim the withholding on his/her/their individual tax return unless one of the exemptions in Question 3 applies. (Source: 2007 California FTB Forms 593-C, 593-E, instructions.) Q 8. Is withholding required if the seller is an irrevocable trust? A Yes, unless one of the exemptions in Question 3 applies. If the seller is an irrevocable trust, the name of the trust and the trust's federal employer identification number (FEIN) is used on all documentation and not the trustee's information. (Source: 2007 California FTB Forms 593-C, 593-E, instructions.) Q 9. Is withholding required if the sale is part of an tax-deferred exchange as defined under Internal Revenue Code 1031? A If the California real property is part of a simultaneous like-kind (IRC 1031) exchange, the transfer is exempt from withholding. However, if the seller receives taxable proceeds (boot) exceeding $1,500 from the sale, then withholding tax must be withheld on the boot. If the 1031-exchange is a deferred exchange, the sale is exempt from withholding at the time of the initial transfer. However, the intermediary or accommodator must withhold on all cash or cash equivalent boot it distributes to the seller (if the amount exceeds $1,500). If the exchange does not take place or it doesn't qualify for nonrecognition treatment, the intermediary or accommodator must withhold 3 1/3 % of the total sales price. (Source: 2007 California FTB Forms 593-C, 593-E, instructions.) 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. (Source: "Real Estate Withholding Guidelines," FTB Pub. 1016, rev ) Q 11. Is withholding required on installment sales?
7 A Yes. However, 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 (Cal. Rev. & Tax Code 18662). The buyer must comply with the installment sale agreement. The seller may instruct the buyer to withhold 3 1/3% on each payment or another installment withholding percentage as specified in box 9 of the seller's election and certification on FTB form 593- B. The buyer must also complete FTB form 593-I and sent both to the FTB with the withholding tax. (Source: 2007 California FTB Forms 593-C, 593-E, instructions.) 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, the seller may be exempt from withholding if there is a loss or zero gain. The seller has a loss or zero gain for California income tax purposes when the amount realized is less than or equal to the adjusted basis in the property. It doesn't matter if the property is being sold for less than what it's worth. If the property is being sold at a loss, the seller must sign an affidavit stating that the property is being sold at a loss. This is accomplished by completing FTB form 593-E. "Real Estate Withholding--Computation of Estimated Gain or Loss," and show a loss or zero gain on line 16 of this form. (Source: 2007 California FTB Forms 593-C, 593-E, instructions.) Q13. Is withholding required when the seller s actual tax liability would be less than 3 1/3 percent? A Yes. However, the seller can have the withholding rate reduced by signing an affidavit under penalty of perjury stating that the tax liability calculated at the maximum tax rate regardless of the seller s actual tax liability would be less than 3 1/3% of the sales price. (Cal. Rev. & Tax Code 18662(e)(2)(B), (C).) (For tax rate for corporations, see Cal. Rev. & Tax Code or 23186; for maximum tax rate for other sellers, see Cal. Rev. & Tax Code ) (See instructions on 2007 California FTB Forms 593-C, 593-E, instructions.) Q 14. Is withholding required on a sale by a probate estate? A In general, yes. However, no withholding is required if the executor/executrix signs an affidavit certifying that the sale is of the decedent s principal residence within the meaning of IRC 121. (Cal. Rev. & Tax Code 18662(e)(3)(D(i)(I).) Q 15. Is withholding required for a foreclosure sale? A No. Withholding is automatically waived if the property is being acquired under a deed of trust or mortgage through a judicial or non-judicial foreclosure or by a deed of trust in lieu of foreclosure. (Cal. Rev. & Tax Code 18662(e)(3)(C)(i)).
8 Q 16. Is withholding required on sales by tax-exempt entities, insurance companies, IRA, qualified pension plan, charitable remainder trust, or the Resolution Trust Corporation (RTC) or other federal, state, or local government agencies? A No. Withholding is not required when the seller is a tax-exempt entity, an insurance company, an individual retirement account, qualified pension or profit-sharing plan, or charitable remainder trust. The seller must certify on FTB form 593-C that it is exempt from withholding because it is exempt from tax under either California or federal law. This applies to religious, charitable, or educational entities among other. Insurance companies are subject to a gross premiums tax and not income tax; and, thus, no withholding is required. The current FTB approach is that the buyer can rely on a written statement from a tax-exempt entity, charitable remiander trust, IRA, qualified pension or a profit-sharing plan, charitable remainder trust, 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. (Source: "Real Estate Withholding Guidelines," FTB Pub. 1016, rev ) Q 17. Who is responsible for the withholding? A The law requires buyers to withhold the required amount (Cal. Rev. & Tax Code 18662). However, buyers typically request the escrowholder to handle this responsibility through written instructions to escrow. If there are two or more buyers, each is legally 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. Note that the buyer is relieved of the duty to withhold should the escrowholder neglect to notify the buyer of this obligation. (However, this does not apply to a 1031 exchange accommodator or intermediary (Cal. Rev. & Tax Code 18662(e)(3)(B)).) (Source: "Real Estate Withholding Guidelines," FTB Pub. 1016, rev ) Q 18. 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 (Cal. Rev. & Tax Code 18662(e)(3)(B)). Q 19. Who is a "real estate escrow person" mentioned in Question 18? 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.
9 (Cal. Rev. & Tax Code 18662(e)(6).) B. Reduced Withholding Q 20. Can the seller request a reduced amount (or no amount) of withholding? A Yes, under certain circumstances. See Question 3 under "Partial or Full Withholding Exemption." C. Handling of Funds and Reporting Q 21. 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 (Cal. Rev. & Tax Code 18662(e)(4)(A)). The parties should usually instruct the escrowholder to perform this function. Q 22. How are withheld amounts reported and transmitted to the FTB? A They are reported and transmitted on FTB form 593, Real Estate Withholding Remittance Statement. The form(s) and the withheld amount should be sent to: Franchise Tax Board P.O. Box Sacramento, California In addition, if there are multiple sellers, the applicable form must be filed for each person subject to withholding. D. Fee Q 23. Can escrow companies charge a fee for this service? A Escrow companies may not charge a fee to notify the buyer of the withholding requirement. They may charge a fee only if they withhold and remit money to the FTB or assists the parties in dealing with the FTB. In this instance, the fee may not exceed $ (Cal. Rev. & Tax Code 18662(e)(7)(D).) E. Potential Liability Q 24. 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 escrowholder?
10 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. (Cal. Rev. & Tax Code 18668(a).) The FTB may also charge interest from the due date to the date paid (Cal. Rev. & Tax Code 18668(b)). 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. (Cal. Rev. & Tax Code 18668(d).) Q 25. 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 escrowholder's reliance upon the seller's affidavit as long as the reliance was in good faith and based on all the facts known to the escrowholder (Cal. Rev. & Tax Code 18668(e)(4)); or due to "reasonable cause" (Cal. Rev. & Tax Code 18668(d)). Q 26. What is the potential liability of the escrowholder for failure to notifythe buyer of the withholding requirements? A When a California real property disposition is subject to withholding, failure of the escrowholder to give written notification of the withholding requirements subjects the escrowholder 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. (Cal. Rev. & Tax Code 18668(e).) Q 27. Are there any situations in which the escrowholder is excused from the penalty mentioned above? A Yes, the escrowholder 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
11 . the escrowholder relies on the seller's affidavit as long as the reliance is in good faith and based on all the facts known to the escrowholder. (Cal. Rev. & Tax Code 18668(e).) Q 28. 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. (Cal. Rev. & Tax Code 18668(e)(5).) F. Seller's Affidavit Q 29. What is the seller's affidavit? A The seller's affidavit (FTB form 593-C or C.A.R. form AS (California portion)) is a document used to obtain an exemption from withholding. In it, the seller certifies, under penalty of perjury, that he/she/it meets one of the withholding exemptions listed in Question 3. 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 (Cal. Rev. & Tax Code 18668(e)(4)). Q 30. Must the seller's affidavit be signed before a notary public? A No. G. The Purchase Contract Q 31. What provision should be made in the sales agreement for compliance with this law? A The purchase contract 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 titled "Withholding Taxes." Parties to transactions who use other contract forms should include an appropriate provision in each agreement.
12 H. California Tax Forms And Publications Q 32. Where can I obtain the Californiatax forms and publications referred to in this legal article? A You can get California tax forms and publications in several ways: 1) Through the FTB s website at 2) By mail at Tax Forms Request Unit, Franchise Tax Board, P.O. Box 302, Rancho Cordova, CA ) By telephone from the FTB s Withholding Section at or ) By fax at the FTB s Forms by Fax at The FTB publishes a brochure, FTB Publication 1016, "Real Estate Withholding Guidelines" that may answer your additional questions. I. Additional Information Q 33. Where can I obtain additional information? A Members and their clients 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 , by fax at , through the FTB s website at or write to Franchise Tax Board Withholding at Source Unit P.O. Box 651 Sacramento, CA This legal article 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 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 , Monday through Friday, 9:00 A.M. to 6:00 P.M. C.A.R. members who are broker-owners, office managers, or Designated REALTORS may contact the Member Legal Hotline at to receive expedited service. Members may also fax or inquiries to the Member Legal Hotline at or Written correspondence should be addressed to: California Association of REALTORS
13 Member Legal Services 525 South Virgil Avenue Los Angeles, California The information contained herein is believed accurate as of Oct. 1, 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. Copyright 2007 CALIFORNIA ASSOCIATION OF REALTORS (C.A.R.). Permission is granted to C.A.R. members only to reprint and use this material for non-commercial purposes provided credit is given to the C.A.R. Legal Department.Other reproduction or use is strictly prohibited without the express written permission of the C.A.R. Legal Department. All rights reserved.
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