California Real Estate Withholding
I sold an investment property in California, why is Escrow withholding tax from the sale, and what is this 593 Form I must fill out?
Welcome to selling Real Estate in California!
Real estate transactions in California are subject to the state's withholding requirements, which are designed to protect the state's tax base by ensuring that taxes are paid on property sales. The California Franchise Tax Board (FTB) is responsible for administering these requirements, which apply to all real estate transactions, including sales of single-family homes, condominiums, townhomes, commercial properties, etc.
When a property is sold in California, the state requires the seller to withhold a certain percentage of the sales price. This withholding is used to pay the seller's state income tax liability on the gain from the sale. Unlike the Feds, California requires the tax to be paid at the time of sale, not at the time the tax return is filed. This almost always comes as a shock to the seller as they assume they don’t have to pay the tax on the gain until the tax return is due. So, the seller usually expects a higher net cash payout at the date of sale and are often disappointed when they see their net check is lower than expected.
The amount withheld by California during the escrow closing depends on the sales price and the of the property, the purchase price, improvements and any depreciation taken.
Of course, the escrow company doesn’t have all of this information and it’s not their responsibility to calculate the gain on sale or the tax to be withheld on the sale for you. This means as the seller you are required to fill out Form 593 and provide it to the escrow company so they know how much to withhold for you. You can find a copy of form 593 at this link → https://www.ftb.ca.gov/forms/2023/2023-593.pdf
The withholding rate for California real estate transactions is 3.3% of the sales price or the value of the property at the time of sale, whichever is greater.
For example, if a property with a sales price of $500,000 is sold, the withholding amount would be 3.3% of the sales price, or $16,500. The buyer must pay the withholding amount to the FTB at the time of the sale, and the seller must file a withholding form (Form 593) with the FTB within 20 days of the sale. Form 593 must include information about the buyer, the seller, and the property that was sold. The withholding amount paid by the buyer is applied to the seller's state income tax liability on the gain from the sale. If the withholding amount is more than the amount owed, the seller will receive a refund from the FTB when they file their tax return. If the withholding amount is less than the amount owed, the seller must pay the difference either via estimates or with their tax return.
In addition to the withholding requirement, the seller must also report the sale of the property on their California state income tax return. The gain from the sale must be reported as part of the seller's income, and any taxes due must be paid when filing the return. The withholding amount will be applied to the taxes due, and any excess will be refunded to the seller. California's withholding requirements for real estate transactions are an important part of the state's tax system, as they help to ensure that taxes are paid on property sales. It is important for buyers and sellers to understand these requirements and comply with them to avoid any penalties or fines. It is also important to understand these so there is no shock when it comes to the net cash you will receive as the seller once the deal is closed.
I do recommend consulting with your CPA to assist you with filling out Form 593 before giving it to escrow. They can help you make sure you are having the correct amount withheld on the sale of the property and help keep you from being over or under withheld on the transaction.
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