Q-1:

Subject: Re: How long to wait for a refund?

Kerry,

I saw your blog about the change in CA Real Estate Tax withholding.

Nice to know, but for me it came about 18 months too late.  No longer live in CA and sold my former home and had the state withhold a massive wad of my money even though I knew I would owe no taxes and they had to give it all back eventually.

Irksome since the IRS didn't require any withholding at time of sale (my profits fit the primary residence sale exemption - but for out of staters CA still requires withholding).

A-1:

Your email brought up a couple of issues that obviously need clarifying.

California has always had an exemption from the withholding for those sellers who qualify for the Federal Section 121 exclusion.  All you needed to do was file Form 593-C with the closing agent (title company) and indicate that you meet the Section 121 rules and no tax would be withheld.  Your personal professional tax advisor should have told you about that before you closed your sale if your Realtor or the escrow agent didn't.  This information is also readily available on the FTB's website.

Hopefully, you have already filed the 540-NR and recovered the money, which became an interest free loan that you provided for the State of California.

A little history lesson.  The California withholding requirement for real estate sales by non-residents was instigated a number of years after a similar law was passed by the Feds requiring a withholding of 10% of the gross sales price from sales of real estate by non-residents of the USA.  The state withholding rate was officially established as one-third the federal rate; thus the 3.333%. 

The concept and motivation for both the Federal and State withholding requirements were the same; to snatch some money up front in an attempt to "motivate" non-resident sellers to "voluntarily" file income tax returns reporting those sales.  Non-resident sellers were always required to file those tax returns long before the  withholding rules were established.  However, when there was no money snatched ahead of time, there was less incentive for sellers to file the required tax returns.  It was always the intent to withhold more money that would actually be due so that sellers would have to file to recover the overpayments.

I hope this helps you better understand the situation. 

Thanks for writing.

Kerry Kerstetter

Q-2:

First off, please ignore the subject line.  I just hit "reply" to an earlier line of conversation we had rather than retype your email and forgot to change the subject line.

 

Anyway, I did go over the withholding requirement with my tax preparer (and he's good, not some H&R Block fly by nighter).  For some reason having to do with the fact that we only qualified for a partial 151 deduction due to not meeting the 2of5 year requirement but having unforseen circumstances, the CA forms would not let us avoid the withholding.  It was odd I recall.  I think possibly the CA forms said we had to be residing there presently to qualify but if we qualify under 151 with IRS, then we don't have to pay taxes.  It was a bit of a catch 22.  I could probably dig out the paperwork and find exactly what the issue was if you're curious.

 

Oh, thanks for the history lesson.  I'm interested in history, but for the tax code I usually say we should just scrap it all and start from the beginning.  I think if a flat tax ever passed it would only take about 20 years of "exceptions" to get us right back here again.

A-2:

While it's water under the bridge for you now, I did just check Form 593-C and its instructions and it does appear that you could have claimed a full exemption from the withholding by checking the YES box next to Question 1 in part II.  The instructions specifically mention the fact that sellers may not have lived there a full two years if selling due to employment, health or unforeseen circumstances and the home would still qualify for the Section 121 tax free exclusion.

Your tax advisor may have interpreted this differently or there may have been another relevant factor involved that would have disqualified you from the exemption.

It's obviously too late to matter for you; but I hope others can learn from this.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 9/29/2006 11:20:00 AM Send this post: