Real estate withholding is a prepayment of California state income tax for out-of-state sellers of California real property. Escrow companies are required to collect 3.33% of the sale proceeds and send to the state on behalf of the sellers.
Now they are hitting the rents too:
Beginning January 1, 2010, property managers will have to withhold 7% of all income, that exceeds $1,500, on properties owned by nonresidents to be sent to the nonresident property owner, unless the owner qualifies for reduced or waived withholding.
This brief Legal Q&A and the FTB Summary Chart of the Withholding Process address the most basic questions. Additional guidance is available from the FTB and tax professionals. (For all the legal citations and FTB authority, see page 4 of FTB Publication 1017 (rev 06-09), Resident and Nonresident Withholding Guidelines.)
Q 1. Who is a California nonresident property owner subject to withholding?
A Nonresident owners include the following:
. Individuals who reside outside of California,
. Corporations, Partnerships and LLCs who do not have a permanent place of business in California or who are not qualified by the Secretary of State to do business in California, or
. Estates and trusts who are nonresidents of California.
Q 2. Who is exempt from withholding?
A Those persons or entities exempt from withholding include the following:
. California residents,
. Corporations, Partnerships and LLCs qualified to business in California or who have a permanent place of business in California,
. Estates where the deceased was a California resident at the time of death,
. Nonresidents when the payments do not exceed $1,500 in a calendar year,
. Tax exempt organizations,
. California nongrantor trusts,
. A nonresident owner who has received either a Waiver or Reduced Withholding Exemption from the FTB.
NOTE: One fairly simple method for nonresident owners to be exempt from withholding is for them to form a California Corporation, Partnership, or LLC, or to have their foreign (out-of-state) Corporation, Partnership, or LLC qualified to do business in California with the Secretary of State. Depending on the income generated by the rental property, the cost of forming and maintaining such an entity may be justified to avoid withholding.
Q 3. What are the steps in the withholding process?
A The property manager should take the following steps:
Step 1 – BEFORE MAKING A PAYMENT TO THE OWNER
Determine the following:
A. Is the owner eligible for a Withholding Exemption Certificate?(FTB Form 590 – http://www.ftb.ca.gov/forms/2009/09_590.pdf)
A California resident or a business with resident status can use Form 590 to certify exemption from withholding. No withholding is required with a withholding exemption certificate.
B.
Is the owner eligible for Nonresident Withholding Waiver Request?(FTB Form 588 – http://www.ftb.ca.gov/forms/2009/09_588.pdf
A nonresident property owner who qualifies can obtain a waiver generally based on prior tax filing history. No withholding is required with a waiver certificate.
C. Is the owner eligible for a Nonresident Reduced Withholding Waiver Request?
(FTB Form 589 – http://www.ftb.ca.gov/forms/2009/09_589.pdf
The nonresident property owner itemizes expenses and, if approved, the FTB provides the property manager a letter stating the reduced withholding amount.
Step 2 – AT THE TIME OF WITHHOLDING
A. Obtain the consent of the owner to pay the withholding out of the broker trust account, if required. This consent is included in the C.A.R. Property Management Addendum (PMAD). [The property manager can send a sample letter
and attach C.A.R. form PMAD to obtain the owner’s consent.]
B. Withhold 7% of the GROSS payments to the owner that exceed $1,500. The property manager can deduct direct property management expenses (property management fee) from the payment before calculating the 7% withholding. If the owner wishes to reduce the withholding due to other property expenses they will need to submit FTB Form 589.
Step 3 – AFTER WITHHOLDING AND MAKING PAYMENT TO THE NONRESIDENT OWNER
A. After making the payment to the nonresident owner the property manager files the Quarterly Resident and Nonresident Withholding Statement.
(FTB Form 592 – http://www.ftb.ca.gov/forms/2009/09_592.pdf
This form is filed quarterly with the forwarding of the withheld amounts to the FTB.
B. By January 31 of the following calendar year, the property manager sends to the nonresident property owner a completed Resident and Nonresident Withholding Tax Statement
(FTB Form 292-B – http://www.ftb.ca.gov/forms/2009/09_592b.pdf
The property owner then files a claim for the withholding when filing their California tax return.
Q 4. What can a property manager do if the nonresident property owner refuses to authorize the withholding?
A This issue was raised at the C.A.R. Property Management Committee meeting that included attendees from both the DRE and FTB. Basically the DRE and FTB are making property managers the enforcers by placing them right in the middle. The DRE says if the property manager withholds without the PMAD (or other authorization), the property manager is violating the trust fund laws and can lose his/her license. The FTB says if the property manager does not withhold, he/she is violating the tax laws and is subject to fines and penalties.
If the owner refuses to sign the C.A.R. form PMAD, or any other written authorization, the property manager has four options:
1. Deduct the withholding without the owner permission and risk violating the Real Estate Law;2. Refuse to withhold without the owner’s permission and risk violating the California Revenue and Tax Code;
3. Convince the owner to form a California corporation, partnership, or LLC, or to have their foreign (out-of-state) corporation, partnership, or LLC qualified to do business in California with the Secretary of State in order to be exempt from withholding;
4. Resign as property manager.
Q 5. Where can I obtain additional information?
A See below for the FTB Summary Chart for Nonresident Withholding and a sample letter to the nonresident property owner prepared by the Franchise Tax Board and the California Apartment Association.
This 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 www.car.org.
CALIFORNIA ASSOCIATION OF REALTORS®
Member Legal Services
525 South VirgilAvenue
Los Angeles, California 90020
The information contained herein is believed accurate as of November 30, 2009. 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.
A SUMMARY OF FTB’s NONRESIDENT WITHHOLDING PROCESS
8/20/09
The chart below briefly outlines the three phases of our withholding process. Please go the ftb.ca.gov and search for withholding for more forms, procedures, and FTB’s Publication 1017, Resident and Nonresident Withholding Guidelines.
|
Phase |
Forms to Use |
Tasks |
|
Before property manager makes payment to nonresident property owner |
FTB Form 589, Nonresident Reduced Withholding Request |
Property owner can use Form 589 to itemize expenses against the California source income. FTB provides property manager a letter stating the reduced withholding amount. |
|
FTB Form 588, Nonresident Withholding Waiver Request |
Property owner who qualifies can use Form 588 to get a waiver from withholding based generally on California tax filing history. Property manager requests a copy of the waiver certificate to keep in records. No withholding required with a waiver certificate. |
|
|
FTB Form 590, Withholding Exemption Certificate |
Property owner who is a California resident or a business with resident status can use Form 590 to certify exemption from withholding. No withholding required with a withholding exemption certificate. |
|
|
At the time property manager makes payment to nonresident property owner |
No FTB forms to use, but you will develop your own internal process for withholding |
Property manager withholds 7 percent of all payments to nonresident property owner that exceed $1,500 in a calendar year, unless owner qualifies for reduced or waived withholding. Property manager can also deduct direct property management expenses (such as property management fees) from payment before withholding. |
|
After property manager makes payment to nonresident property owner |
FTB Form 592, Quarterly Resident and Nonresident Withholding Statement |
After making payment to nonresident property owner, property manager sends to FTB a timely, completed Form 592 including the amount withheld for the quarter. Form 592 contains a list of all property owners withheld upon during the quarter. FTB distributes the withholding to the property owners’ accounts. |
|
FTB Form 592-B, Resident and Nonresident Withholding Tax Statement |
By January 31st following the end of the calendar year, property manager sends each property owner a completed 592-B and keeps a copy for records.Property owner claims the withholding by attaching a copy of the 592-B when filing the required California tax return. The 592-B is proof of California source income and withholding. | |
FOR A SAMPLE LETTER TO SEND TO THE NONRESIDENT OWNER, click here .
Awesome. As a non-resident rental owner (who also has to pay state income tax on a percentage of my income deemed to be originated from CA), that’s potentially fair, but if I’m reading this right, a property manager has to withhold. If the tenant sends to me directly (or an out-of-state manager), doesn’t. That’s nice. And, since the rentals are essentially net losses under the tax code, they are just holding my money. I may have to alter my ownership structure or change my PM relationship.
Nice.
“And, since the rentals are essentially net losses under the tax code, they are just holding my money.”
Net Losses? Really?. Hmm. I own (not rent from Lloyd Blankfein or Lewis) 5 fully leased rental properties. I assure you, they aren’t considered anything but ordinary income after deductions. I guess I should have been listening to you not my Enrolled Agent…. As for collecting taxes for other states – well, we’ll see how THAT works…
remember “Jobless Recovery”…LOL.
The posts are geting funnier and potentially financial dangerous as this Depression worsens.
Good Luck with those ‘losses’… I see an IRS person in your future…
@3rd Gen,
I have notes on my property. The rental income – the interest – depreciation – property fees – repairs – taxes and other expenses is usually right around zero. The last two years I had two extended vacancies which made it less than zero (although not by much). I’m still working and a “highly-compensated” person under IRS terminology, so having minimal to no net income is a-ok with me right now.
Also, please don’t listen to me, I am not a licensed tax professional. Please seek your own counsel. What I do may or may not be right or legal for you. And, this isn’t an IRS problem, its a FTB problem.
As someone who pays taxes in 7 states (including the one I live in) and thre foreign countries, let me assure that collecting tax in a different state is pretty easy.
Seems to me that the net effect of this is that most out of state investors who want to stay in California are like Former RB Resident who will find a way to beat the withholding. Could mean that a few more California LLCs and Corps will be formed in 2010.
For those other out of state (or out of country) investors who hear about this, they may increasingly tend to pass on investing here as the reputation of California as an out of control run away train increases. Less competition for us locals.
more red tape as usual.Trying to bring in revenue anyway they can to justify the huge salaries in state govt.
Former RB,
As a “highly compensated” person under IRS terminology, you should know that passive losses are not taken against active losses.
Taking “active” losses for rental properties in another state is red flag. Just remember that if you over-deduct, you can suffer not only repaying past taxes (I believe the statute of limitations is 7 years, but consult a tax professional with more current information) but also have to pay penalties, which can be onerous in comparison to the small benefit.
In most cases, out of state rental properties only make sense if values are going up. People do NOT get tax benefits from losing properties. I recommend reading Publication 925 from the IRS for more info.
BTW, I’m not familiar with the IRS definition of “highly compensated” individuals. Can you point me in the direction of some publication that gives us more information on that classification. I’d like to read up on it.
Your passive-aggressive friend,
Chuck Ponzi
from peter schiff:
“While it is true that home prices have stopped falling, this represents failure, not victory. True success would be a drop in home prices to a level that potential homebuyers could actually afford. Instead, we have maintained artificially high prices with tax credits, subsidized mortgage rates, low down payments, and foreclosure relief.
With 96% of new mortgages now insured by federal agencies, market forces have been completely removed from the housing equation. With so many government programs specifically designed to maintain artificially high home prices, devastating long-term consequences for our economy are inevitable”.
@Chuck,
I do know tax law and am aware of the PAL hotchpot. The ideal scenario for me is zero net income on the property. Sometimes its a little bit more than that, sometimes less, which usually doesn’t help unless I can carry it over. My taxes are well-looked after.
I think you’ve missed my point. Generally, I’m not looking for a deduction, I’m looking for self-funded purchase of property. You’ve cited IRS regs, which isn’t the problem is that CA wants my manager to withhold a straight percentage of the rent and then I have to get it back when my CA income on the property equals zero. Given that I can’t use CA IOUs to pay my NY or MA or CT taxes, I would just assume keep my money and write them a check in the rare instance where I owe.
As buy a house suggest, I’m going to talk to my guys and see what I should do. Given that CA isn’t credit-worthy, I’m not floating them money. My manager will probably get a little letter directing them not to withhold this tax or I will report them to the BOR.
Former RB Resident-
If you have filed CA tax returns the past two years and are not a CA resident, you are exempt from withholdings for two years with a completed and approved Form 588 from the FTB (you can also be exempted if you are making estimated payments to the FTB). The situation you describe above is in filing Form 589 for reduced withholding. Most of the rentals I handle with out of state owners, the witholding is close to zero with the regular Schedule E deductions (except depreciation not allowed). So far I have about 50 hours into the paperwork.
Former RB Res-
Also- a note to your CA property manager will not work, this is law- I noted CA Revenue & Taxation Code #18662 during a seminar. Your tax people can help you with the forms.
None of this should be construed as tax advice as I am not a tax professional.
Fortunately, the FTB hasn’t figured out how to get out of state property managers to fork over withholding for their California clients. I’m sure that’s the next target, although it will be tough to prove situs for the managers.
Former RB Resident is in that sweet spot where he can get his taxable income from his rentals to be near zero and not have to carry over any large passive losses. He has tax-sheltered net income (that’s money in the bank, folks) to the extent his paper depreciation loss covers his positive net income. Well managed, FRBR!
Therein lies the problem of a flat rate withholding. If you owe nothing, they’re basically holding your money.
Since November, practically *every* California has gotten hit by this, now that they’re withholding 110% of what you owe. I.e. the tax rate for most families in California is 9.3%, but they now withhold 10.23% just to f**k with you. You get back the extra 10% when you file your taxes.
Why stop there? Why don’t they and the Fed just hold 100% of your paycheck until you file your taxes and get it back in one lump sum?
why should the property manager be crucified for doing what is right,,,but then what is right? we are employees, the owner whom we represent is our employer…we are going to tell our client to shove it,,,because if we don’t we are fined, if we do, we lose are management income…and then who will the FTB choose to castigate? this whole mess is leading to disaster..who the hey came up with this? a recall is in order for someone besides we property managers!
Just more and more intrusive government! They, the state can’t get its financial act together in terms of its budget responsibilities. Just resort to the same old answer, more taxes and an ever more oppressive bureaucratic system. All the brains of our great state are either gone or are just to smart to try to fix our ever growing mess we call state government. Can’t wait to vote in this up-coming November election. Time for a clean sweep!!!!
I was already “forced” out of CA in order to keep a decent job,and I thought keeping our house would be wise…is it worth paying the CA real estate tax, and this rent tax on top? I don’t know. It seems the government might end up with all property at some point and we will just go back to being surfs tilling the land for rotten potatoes.