Ch. 16 Real Estate Taxation
Determining the profit or loss on a sale is a three-step process.
1. Calculate what's called the "adjusted cost basis." This is the original purchase price, plus improvements, minus depreciation (not applicable on personal residences). 2. Calculate what's called the "adjusted sale price." This is the sales price minus any sales expenses 3. Calculate the gain by subtracting the adjusted cost basis for the adjusted sales price.
The depreciation schedule for rented homes and apartments is a minimum of ____ and for commercial buildings a minimum of ____.
27.5 years 39 years
Veteran's exemption
A CA war veteran is eligible for $4000 exemption against the assessed value of one property. Also applies to the unmarried spouse of a deceased veteran. A veteran cannot take both a homeowner's exemption and a veteran's exemption.
Personal residence - Capital gains
A client selling a home has great tax advantage available. A seller can explode up to $250,000 of any capital gain on the sale. If the sellers are married couple that files jointly they can exclude up to $500,000 in gain. This exclusion can be used once every two years. The seller must have lived in the home to two out of the last five years to qualify.
What are the capital gains exclusions associated with the sale of a personal residence?
A single seller can exclude up to $250,000 of gain and a couple can exclude up to $500,000.
Property taxes - Change in Ownership Statement
Any person who acquired property that is subject to taxes must notify the county recorder or assessor by filing a change in ownership statement within 45 days of the date of recording or if not recorded, within 45 days of the ownership change. If this is not done, the owner will pay penalty of $100 or 10% of the taxes applicable to the new valuation, whichever is greater.
CAR has a form that states that the sales price is less than $300,000 and the home will be used as the buyer's primary residence and should be signed by the buyer.
Buyer's Affidavit
Disabled Veteran
Depending on the level of disability, a disabled veteran could not be eligible for an exemption of up to $191,266 at this writing against the assessed value of the home.
Homeowner's exemption
Every residence that is owner-occupied as of March 1st is eligible to receive a homeowner's exemption of $7,000 of the assess value. For example: Family occupies their primary residence on or before March 1 and their home is valued at $200,000, the assessed value of the property for tax purposes will be reduced to $193,000.
What happens if a property sells higher than $250,000 or $500,000 for a couple that files jointly of the capital gains on that sale?
In either of those cases, the person will have a capital gain (or loss) that will trigger a tax event. Capital gains are taxed at a lower fare than ordinary income. Capital losses can be deducted from capital gains. The lower tax rate on capital gains encourages investors to risk making a long term investment.
Property Taxes
It's important for buyers to understand that they will receive one tax bill, which may be followed by one or mode supplemental tax bills. The county assessor puts new values on a supplemental tax roll from the date of change of ownership. If the new value is greater than the current assessed value, a supplemental tax bill will be sent to the new owner that reflects the high valuation for the remainder of the tax year.
Under what circumstance can a loss on the sale of a personal residence be deducted from income taxes?
Normally, under no circumstances. But if the property is converted to an income-producing rental, then a loss on the subsequent sale could be deducted.
What items can an owner of an income-producing property deduct that an owner of a personal residence cannot?
Operating expenses and depreciation.
Senior citizen's property tax postponement
Persons who are 62 years of age or older and who have a household income of $24,000 or less may be eligible for this program. Qualifying participants have the option of allowing the state of CA to pay all or part of their property taxes. In return, the state will place a lien on the property for the amount of the taxes the state pays. The lien will become payable when the senior sells the residence or dies. This assistance program is also available to persons of any age who are disabled and meet the income requirement.
What is important for a broker to remember about the Foreign Investment in Real Property Tax Act?
The buyer is responsible for withholding 10% of the sales price if the seller is a foreigner and the home is priced over $300,000. If the money is not withheld, the buyer and broker are equally responsible and the broker could end up paying the entire unpaid taxes due.
Installment Sales Tax
The buyer makes payments for a property over more than one calendar year. Person use installment sales to help spread a gain over more than one calendar year to avoid having the entire gain taxed in the first year.
For whom do property tax exemptions exist and for how much?
There is a homeowner's exemption for $7,000 against the assessed value and a veteran's exemption for $4,000 against the assessed value.
Straight-line depreciation
When depreciating property, the amount of depreciation must be allocated evenly over the useful life of the property.
What does proposition 58 state?
allows the transfer of property from one spouse to another or to children without triggering a reassessment.
In order to get the full exemption, a homeowner should file for the exemption
between January 1 and February 15. Once the exemption is filed, it remains on the property until the owner terminated it. The homeowner is responsible for letting the assessor know when the property is no longer eligible for exemption. Failure to notify the assessor could result in an assessment with the interest plus 25% penalty.
When is real property reassessed?
every time it is transferred.
The county assessor determines the amount of real property taxes (also called ad calorimeter taxes) based on
the assessed value of the property.
Property taxes - fiscal year
Starts on July 1 and ends on June 30
Regressive Tax
•Uses the same rate regardless of income. •Example: State sales tax
Homeowners can typically deduct these 3 items from their annual income taxes:
1) Mortgage loan interest - This is a major advantage of owning a home. A person can finance up to one million dollars ($1,000,000) and deduct all of the interest paid out for the year on that loan. A portion of the interest on home equity loans, and loans to purchase a second home may also be deducted. The deduction is limited to interest on the first $100,000 of such loans. 2) Property taxes - These taxes are deductible for both first and second homes. 3) Prepayment penalties - If a client is assessed a prepayment penalty for paying off or drastically reducing a loan amount, he or she can deduct the penalty from income taxes.
Documentary Transfer Tax
A California State tax that is levied upon the transfer of real estate, at the rate of $0.55 per $500.00 of consideration, or fraction thereof. For example: For a $175,000 home, the transfer tax would be $192.50. $175,000 \ $500 = 350 x $.55 = $192.50
Proposition 13 - example
Jim Jones purchased a home last year for $250,000, Their tax bill for last year was $2,500. Assuming an inflation of 1.5% this year, the market value of their home would be $253,750 ($250,000 x 1.015) and their taxes will be $2,537.50. The Jones' future property tax bills can be calculated using the same process for each subsequent year they own the property.
What happens if a person loses money on the sale of a residence? Can the loss be deducted from income taxes?
No, however there is one way to change that circumstance. If the client turns the property into income-producing property by renting it, then any loss resulting from that sale would be deductible.
Special Assessment
Not technically a property tax. This tax is actually levied by a city council or a county board of supervisors and requires voter approval. A special assessment tax is usually levied only once and is done so to offset the costs of specific local improvements, such as streets, sewers, irrigation, drainage, or flood control. According to state law, cities or counties may establish a special assessment district board to levy a special assessment. The district usually issued its own bonds to finance the improvements and then assessed all the properties in the district to repay funds.
CAR has a form that a seller can sign attesting that he or she is not a nonresident alien. Signing the statement can relieve the broker and buyer of liability for any unpaid taxes.
Seller's Affidavit of Nonforeign Status and/or CA withholding Exemption.
Property taxes - Exemptions
Some properties that are assessed are actually exempt - wholly or on part. All government institutions, some non-for-profit educational entities, many churches and many charitable organizations are exempt. There are also exemptions or other types of relief for: •Homeowners •Veterans •Seniors
Explain the documentary transfer tax.
The California tax laws allow a county or city to adopt a documentary transfer tax to apply to the transfer of properties located in the county. The tax is computed on the total price paid for the property, less any assumed loans. The tax is computed at the rate of 55 cents for each $500 of consideration or fraction thereof.
Straight trade
•An exchange that is tax-free. •A property is exchanged for one of equal value. •But often that is not the case. •If the properties are not of equal value, one party may receive cash or mortgage relief to "equalize" the transaction.
Boot
•Any cash relief one party receives in addition to the actual property. •The person not has net gain and must pay taxes on it. In this situation, the exchange is not fully tax-free, only partially tax-free.
Under IRS section 1031, a property that is held for productive use in a trade or business can be exchanged for like-kind property. Like-kind property includes:
•Apartments and residential rentals •Commercial property •Industrial property •Farms or land The properties must be "like-kind" in nature or character, not in use, quality or grade. For example, farm could be exchanged for a store building, vacant land for an apartment building, or a rental home for vacant land.
Proposition 13
•Approved by CA voters on Jun 1978. •Amended the State Constitution so that the maximum annual tax in real property is limited to one percent of "full cash value," or market value, plus a maximum two percent increase in market clacking per year.
Seller's and Buyer's Affadavit
•Both forms together immediately exempt the buyer from the withholding requirement. If neither form can be truthfully signed, the broker should make sure that the 15% is withheld in escrow.
Foreign Investment in Real Property Tax Act (FIRPTA)
•Congress passed in 1985 to eliminate the problem of collecting delinquent taxes from foreigners who owned and sold property in the US and left the country without paying the taxes due on the sale. •Requires a buyer to withhold estimated taxes equal to 15% of the sale price (10% for dispositions before February 17, 2016) in any sale or exchange of property owned by a foreigner. The IRS keeps this 15% to ensure that any capital gains on the sale are paid. Note: Residential property that sells for under $300,000 and will be used as the buyer's personal residence is exempt from the requirement.
FIRPTA - Since the broker could be held liable, it's imperative for the broker to:
•Find out the citizenship or non-foreign status of all sellers of residential property that is priced at $300,000 or more. Be sure to require this information, even if someone does not appear to be foreign. •When taking a listing, require a statement of non-foreign status from the seller.
Tax Deferred Exchanges
•In an exchange transaction. •The exchange is not really tax-free; it is tax-deferred. Taxes will be owed at the time the exchange property is sold. •Because property appreciates in value, many owners do not want to sell and pay the high taxes associated with the gain on the property. So a tax-fee exchange could be a viable option.
Like homeowners, investors of income-producing properties can deduct these three items from their income taxes:
•Mortgage loan interest - There is no maximum loan amount for investors. •Property taxes •Prepayment penalties
The amount due in property taxes can be a confusing issue at the time a property is sold. Depending on the timing, seller may have paid:
•None is the taxes for the upcoming year (for example sale closed July 15) •Half the property taxes for the fiscal year (a sale that closed on December 15) •All the property taxes for the fiscal year (sale that closed on March 15) Escrow will prorate taxes using the seller's assessed value as of January 1.
Timetable for how taxes work:
•On January 1, the taxes for the upcoming fiscal year become a lien on the property. •Tax year begins on July 1. •On November 1, the first installment for half the taxes becomes due. •On December 10, at 5pm, the first installment becomes delinquent if not paid and a 10% penalty charge is added to the bill. •On February 1, the second installment for the balance of the taxes comes due. •On April 10, at 5pm the second installment becomes delinquent if not paid and a 10% penalty charge is added to the bill. Note: If taxes are due on a weekend or holiday, the due date or delinquency date is extended to the close of the next business day.
Unlike owners of personal property residences, investors can also deduct:
•Operating expenses - These are recurring costs, such as interest, insurance and taxes. •Depreciation of improvements - This is a deduction for wear and tear on "improved" investment property. An investor can depreciate apartments buildings, commercial buildings and improvements to other investment property, but land cannot be depreciated.
Property 13 - Exemptions
•Proposition 58 allows the transfer of property from one spouse to another or children, without triggering a reassessment. •Based on Proposition 60 and 90, homeowners may be permitted to transfer their current Proposition 13 tax based with them if all of the following conditions apply: **At lease one of the homeowners must be 55 years old. **The replacement property must be purchased within two years of the original sale. **The new home must be of equal or lesser value if the recordings are simultaneous. If the new property closes during the first year after the old home, the price may go up by 5%, and if the new property closes during the second year after the old home, the price may go up as much as 10% over the old selling price. **The new home must be in the same county (or in another "participating" county.)
Property taxes - Real property
•Reassessed every time it is transferred. •Property tax is usually set at 1% of the selling price. So it's fair to say that the more valuable a property is and/or the more current its acquisition date, the higher the taxes will be. *For example, if an owner purchased a home 5 years ago for $150,000, the property taxes would have started at $1,500. If that same home sells today for $450,000, the new owner will start out with a tax bill of $4,500.
Progressive Tax
•The rate increases as the amount into be taxed increases. •The more money a person makes, the higher the taxes will be. •Higher income families pay most of the income taxes.
California has adopted its own law dealing with sales of real property by foreign persons who are not US citizens or US resident aliens. This law states that if the foreign seller's last know address is outside CA, the buyer may be required to set aside 3.3% of the sales price for the Franchise Board. Exemptions to this rule include:
•The sale price is $100,000 or less. •The property is the seller's primary residence. •The seller signs a CA Residency Declaration. •The seller receives a waiver from the franchise tax board. As with the FIRPTA rules, the broker and the buyer could be liable for the tax if it is owed and not paid. **Note: Brokers and buyers must keep the documentation regarding these foreign sales for 5 years.
