California Differences - Rental Activities
Generally, California law is the same as federal law concerning PAL limitations. However, for California purposes, all rental activities are passive activities, and California does not conform to federal treatment of Real Estate Professionals’ passive losses (IRC Sec 469(c)(7)). Therefore, for purposes of California personal income tax, taxpayers should group rental activities without regard to IRC section 469(c)(7) (see the guide Real Estate Professional Tax Overview).
Withholding on Rents Paid to Non-Residents
7% withholding is required from rents paid to non-residents on real or personal property located in California if the rent is paid in the course of the withholding agent’s business (e.g., a property management company). Form 592-B will be issued to the FTB and the non-resident property owners showing the amount withheld during the year. Withholding is not required if the withholding agent’s total payments to the payee are $1,500 or less for the calendar year. The FTB issues a determination letter for each waiver request. A withholding agent must have received the determination letter authorizing a waiver of withholding before eliminating withholding on payments made to non-residents. The withholding agent retains the determination letter and waiver for a minimum of four years and must furnish the form to the FTB upon request. Use FTB Form 588 to request a waiver of withholding and for additional details related to this requirement. Note: No withholding is required to be made by tenants of residential property who make their payments directly to non-resident owners.
Form 593
For transactions that close after January 1, 2020, revisions to Title 18 of the California Code of Regulations (CCR) Section 18662 include consolidating Form 593, Form 593-C, 593-E, and 593-I into one form, and the updated Form 593, Real Estate Withholding Statement, should be used. Thus, besides reporting the amount of the real estate withholding on Form 593, the following actions will also be completed on Form 593:
-
Certifying any exemptions to the withholding requirement.
-
Electing to calculate withholding based on gain rather than the sales price; and
-
Withholding by the buyer for instalment sale payments.
Withholding for Real Estate Sales
Withholding on real estate sales includes all individuals, both resident and non-resident. In addition, the FTB will not grant individuals a waiver or reduced rate of withholding for sales with small taxable gains. However, there are some exceptions in the law. Withholding is not required if:
-
The sales price is $100,000 or less (when multiple sellers are involved in the transaction, the withholding is determined by the total sales price, not by each seller’s portion)
-
The property sold was a principal residence (including a decedent’s residence if being sold by the decedent’s estate)
-
Sale results in a taxable loss
-
The sale is a tax-free exchange, or
-
For some involuntary conversions.
Also exempted are sales where the seller is a tax-exempt entity, a California corporation with a permanent place of business in California, or partnership or LLC (but an LLC treated as a disregarded entity is subject to withholding).
Withholding on Foreclosures and Short Sales
If the total sales price is over $100,000, withholding for real estate foreclosures and short sale transactions is required unless:
-
Any of the exemptions certified on Form 593 apply, or,
-
The seller is a bank acting as a trustee (other than a trustee of a deed of trust), or,
-
The buyer is acquiring the property as part of a foreclosure under one of the following conditions:
-
A power of sale required under a mortgage or deed of trust.
-
A decree requiring foreclosure.
-
A deed in lieu of foreclosure.
-
Caution
State income tax withholding is not deductible for Federal AMT purposes and therefore can create a Federal AMT and unexpected tax results. Practitioners are cautioned to consider the Federal AMT implications associated with a sale for which CA withholds state income tax which in some cases can be substantially excessive. However, with the $10,000 limitation on the deduction of state and local taxes imposed by the TCJA for years 2018 through 2025, fewer individuals will be subject to the AMT because of their deduction for real property tax (and other reasons). But this doesn’t mean that the CA withholding on real estate sales will be any less for these individuals, just that they may more likely be subject to the SALT limitation on their federal returns.
Sellers of California real property will be given the option to select a withholding rate of 3.33% of the sales price or, one of the following applicable rates multiplied by the reportable gain from the sale:
-
8.84% (Corporate franchise rate)
-
10.84% (Bank and financial corporation tax rate)
-
15.8% (Financial S Corporation)
-
13.8% (S Corporation)
-
12.3% (Individuals, trusts and non-California partnerships)
Seller Certification
A seller making the election must certify the withholding amount in writing, under penalty of perjury, to the buyer or the real estate escrow person. The seller also must submit a copy of the written certificate and supporting documentation for the withholding amount to the California Franchise Tax Board (FTB) upon request. The written certification must be in a form prescribed by the FTB, currently Form 593. The FTB makes the form available on its Web site and provides electronic means for a seller to estimate the amount of gain required to be recognized on a transaction.
Installment Sales
For dispositions subject to real estate withholding, buyers are required to withhold on the principal portion of each installment payment if the sale of California real property is structured as an installment sale.
Withholding Responsibility
-
Real estate escrow person (REEP) - is responsible to provide the buyers with written notification of their withholding requirements unless the buyer is an intermediary or accommodator in a deferred exchange and may assist the buyers in their withholding requirements by performing or assisting in the withholding, completing the required withholding forms, and/or remitting the required withholding to the FTB. The REEP will withhold the required amount in escrow on the down payment and remit it to the FTB by the 20th day of the month following the close of escrow, along with Forms 593, 593-V and a copy of the signed promissory note., Retain copies for 5 years.
-
Buyer – For all subsequent payments where the REEP isn’t involved in withholding from payments and transmitting the tax to the FTB, the buyer is required to withhold the required amount from the installment payment due the seller, and remit it to the FTB within 20 days accompanied by Forms 593 and 593-V.
The Withholding Amount
-
3 1/3% of each principal payment (initial payment in escrow and each subsequent payment), OR by election,
-
The seller’s tax rate (12.3% for an individual regardless of what the individual’s actual CA tax rate is) times the product of multiplying the principal payment (initial payment in escrow and each subsequent payment) by the gross profit percentage.
Buyer’s Certification
The buyer is required to complete and sign Form FTB 593, acknowledging the installment sale withholding rules and agreeing to transmit to the FTB (with a copy to the seller) a completed Form 593 and the required amount of withholding by the 20th day of the month following the month of each installment payment. The buyer must advise the FTB if there are changes to the terms of the sale, promissory note or payment schedule. The buyer is subject to penalties for failing to withhold or submit the withholding timely to FTB or if a copy of the Form 593 is not timely provided to the seller. These penalties are:
-
Buyer (after notification) does not withhold – penalty is up to $270 or the greater of $500 or 10% of the required withholding due to intentional disregard of the requirement.
-
Form 593 filed late – For filings on or after January 1, 2020: within 30 days of due date, penalty is $50 per Form 593; filed 31 days to 6 months late, penalty is $110 per Form 593; filed more than 6 months late, penalty is $270. For filings before 1/1/20, these amounts were $30, $60 and $100, respectively. If failure is due to an intentional disregard of the requirement, the penalty is the greater of $550 ($250 for pre-2020 filings) or 10% of the required withholding.
These mandatory withholding rules don’t apply for instalment sale payments for sales agreements made prior to 2009.
Withholding When a Trust Is the Seller
Oftentimes there is confusion as to what name and ID number should be used on Form 593 when real estate subject to withholding is sold by a trust. The FTB says that if the seller is a grantor trust, Form 593 should be completed using the grantor’s individual name and taxpayer identification number. The name of the grantor trust should not be entered on Form 593 since the grantor trust is disregarded for tax purposes and the individual seller must report the sale and claim the withholding on their individual tax return. On the other hand, if the seller is a non-grantor trust, Form 593 should be completed using the name of the trust and the trust’s FEIN. Trustee information should not be entered on the Form 593, because the withholding credit belongs to the trust.
Additional Information – Please also see FTB Publication 1016, Real Estate Withholding Guidelines, and the instructions to Form 593, both of which are available on the FTB website.
Claiming Real Estate Withholding
Taxpayers claim the withholding amount shown on Form 593 on Form 540, line 73 (2021).