When buying or selling real estate, taxes are often the last thing people want to think about. However, overlooking them can lead to costly surprises. Real estate tax withholding is one of those essential yet often misunderstood aspects of property transactions. If you’re selling property in California or working with a foreign seller, understanding tax withholding laws is essential to avoid penalties and ensure a smooth transaction.
In California, the Franchise Tax Board (FTB) enforces specific rules for non-resident sellers, while the Foreign Investment in Real Property Tax Act (FIRPTA) applies at the federal level for foreign sellers. Both regulations are designed to ensure that the government collects the correct taxes from real estate transactions — but the rules, rates, and exemptions can be tricky to navigate.
What is Real Estate Tax Withholding?
Real estate tax withholding refers to the practice of withholding a portion of the sale proceeds to cover potential tax liabilities. This ensures that the government collects any taxes owed before the funds are transferred to the seller. In most cases, the responsibility for withholding falls on the buyer, although the escrow company often facilitates the process.
When is withholding required?
- Sale of California real estate by a non-resident seller.
- Sale of U.S. property by a foreign seller.
- Transactions where the seller may have a tax liability.
Franchise Tax Board (FTB) Requirements
In California, the Franchise Tax Board (FTB) oversees state tax withholding requirements on real estate transactions. When a property is sold by a non-resident, California requires the buyer to withhold 3.33% of the sale price or an alternative calculation based on the seller’s potential gain.
Exemptions:
- If the sale price is under $100,000.
- If the seller is a California resident (proper documentation required).
- If the property was the seller’s primary residence for at least two out of the last five years.
- If the seller meets specific exemption criteria, such as a 1031 exchange.
Forms and Reporting:
- Form 593 – Real Estate Withholding Statement (used to report and remit withheld taxes)
- Form 593-C – Certification of Exemption from Withholding
More details are available on the Franchise Tax Board’s official website.
Foreign Investment and Real Property Tax Act (FIRPTA)
FIRPTA is a federal law that requires tax withholding when a foreign person sells U.S. real estate. Enacted in 1980, FIRPTA ensures that foreign sellers pay taxes on capital gains from U.S. property sales. This applies to non-resident aliens, foreign corporations, partnerships, trusts, and estates.
Withholding Rates:
- 15% of the sale price (if over $1 million).
- 10% of the sale price (if $300,000–$1 million).
- No withholding required if the sale is under $300,000, and the property is intended for use as a primary residence.
Exemptions:
- If the seller provides a withholding certificate from the IRS.
- If the transaction qualifies for a tax-deferred exchange (like-kind exchange).
Forms and Reporting:
- Form 8288 – U.S. Withholding Tax Return for Dispositions by Foreign Persons.
- Form 8288-A – Statement of Withholding on Dispositions by Foreign Persons.
For more information, you can check FIRPTA’s official website.
How FTB and FIRPTA Affect Real Estate Transactions
Both FTB and FIRPTA withholding requirements mean that buyers and sellers need to carefully evaluate the tax implications of a real estate transaction. For California residents, FTB withholding is the key factor. For foreign sellers, FIRPTA takes precedence, and compliance with federal regulations is essential. In some cases, both FTB and FIRPTA may apply, leading to double withholding.
When agents understand rules like FIRPTA and FTB withholding, they can confidently guide their clients through the process and ensure all tax obligations are properly handled. Knowing how tax withholding works allows agents to anticipate potential issues, avoid penalties for their clients, and build trust by providing valuable advice. If tax withholding isn’t handled correctly, it can delay closings or lead to unexpected costs for the seller, which reflects poorly on the agent.
Agents can ensure they are informed and compliant with tax regulations by partnering with experienced escrow officers and attending industry training sessions that focus on real estate tax regulations. Not only will it protect your clients, but also enhance your reputation and expertise in the market.
Key Takeaways
- California’s Franchise Tax Board (FTB) requires 3.33% withholding on the sale price or gain unless the seller qualifies for an exemption.
- Foreign sellers are subject to a 15% FIRPTA withholding, unless exempt.
- Non-compliance with FTB or FIRPTA withholding can result in penalties and interest charges.
- The escrow company or settlement agent typically handles the withholding process.
- Consulting with a tax professional can help identify potential exemptions and reduce withholding liabilities.
Franchise Tax Board. (n.d.). https://www.ftb.ca.gov/
Internal Revenue Service. (n.d.). https://www.irs.gov/
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