Certain sellers to pay sooner

Under a new state law, residents and nonresidents who sell any home in California other than their primary residence will be required to withhold 3.33% of the sales price and turn the money over to the Franchise Tax Board. The California Investment in Real Property Tax Act, which goes into effect Jan. 1, is expected to affect 300,000 California real estate transactions worth $6.8 billion and will increase state revenue by $225 million for fiscal year 2002-2003, according to information released by the Franchise Tax Board.

Although the new law does not impose new taxes or increase existing taxes, it accelerates the receipt of tax revenue to the state through withholding on investment properties, said June Barlow, vice president and general counsel for the California Assn. of Realtors.

Typically home sellers pay taxes on the gains from the sale of a property when they file tax returns. Under the new law, the state will get funds at the time of the sale.

Sellers who owe less than the funds withheld will get a refund later when they file their tax returns. Even if the seller can prove the withholding will exceed the gain, no waivers will be allowed under the law, Barlow said.

A property owner who sells a rental unit or vacation property worth $500,000, for example, will give the state $16,650 in withholding, regardless of the actual gain to the seller. If the owners paid $450,000 for the property, they still will have to withhold tax on the entire $500,000 sale, not the $50,000 in actual gain.

To owe $16,650 in taxes, the owner of that property would have to have pocketed a gain of about $180,000.

“Most sellers won’t find out about this new law until they enter escrow,” said Mike Cain, a partner with Carlson, Safer, Cain & Smith, a Woodland Hills accounting firm. “They’ll be shocked, and they’ll be powerless to do much about it.”

There are, however, a few exceptions to the new law. Withholding will not be required, for example, if the home sale price is less than $100,000. Exemptions also are permitted if the home is sold at a loss or if it is exchanged for a like property.

Under the new law, escrow companies are required to inform buyers and sellers of their withholding obligations. If an escrow company fails to do so, the escrow agent will be subject to penalties: $500 or 10% of the amount required to withhold, whichever is greater.

“This law causes another complication in escrow,” Barlow said. “Many people sell because they want the money, but now they won’t get as much up front.”

Sellers who have minimal equity in their home will have to foot the withholding bill from their own pocketbooks. And sellers who get a big refund may get hit with a higher adjusted gross income the following year, which could affect their tax planning, Cain said.

While some owners may be put off from selling their properties, others might find ways around the new law, possibly by restructuring the sale into an entity such as an irrevocable trust or placing the property into a corporation, for which different withholding rules apply, legal experts said.

Cain said it’s not easy to move real estate into corporations, however. Those transactions can involve real estate taxes, changes of title and other issues that many individuals would not want to tackle.

For wealthier investors, the law will barely make a ripple. “People with more money have fewer things to complain about,” said Boyd Smith, a Coldwell Banker Previews agent in Pasadena. “This may just be a topic of discussion for the holiday season, and then it will burn away.”