Ch. 16 - Real Estate Taxation
According to FIRPTA, what percent would a buyer need to withhold when purchasing a $200,000 home from a foreigner?
0%
How long must buyers and brokers keep the documentation on a foreign sale?
5 years
PROPERTY TAXES Veteran's Exemption
A California war veteran is eligible to receive a $4,000 exemption against the assessed value of one property. This exemption also applies to the unmarried spouse of a deceased veteran. Depending on the level of disability, a disabled veteran could be eligible for an exemption of up to $191,266 at this writing against the assessed value of the home. These exemptions are compounded annually by an inflation factor so for the most up to date figures check with the California State Board of Equalization at http://boe.ca.gov/proptaxes/dv_exemption.htm Note: A veteran cannot take both a homeowner's exemption and a veteran's exemption. If the veteran is eligible for only the $4,000 exemption, it might be a better option to apply for the homeowner's exemption.
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.
INCOME TAXES Installment Sales
An installment sale is one in which the buyer makes payments for a property over more than one calendar year. Persons 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. Since income taxes are progressive, if the gain is allocated over two or more years, the result could be that the income will be taxed at a lower rate. If a seller can avoid paying taxes on the entire gain in one year, he or she can save substantially on income taxes. This is particularly effective for someone like Tom (in our earlier example), whose income would jump due to the $425,000 gain on the sale of his commercial property. This could force Tom into a much higher income tax bracket.
Homeowners can deduct all but which of the following from their income taxes?
Depreciation
How can a seller lessen the tax impact of selling a home for enough profit that he or she will be boosted to a much higher tax bracket?
Do an installment sale.
When is the first installment of property taxes due?
First of November
INCOME TAXES Personal Residence
Homeowners can typically deduct these three items from their annual income taxes: 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. Property taxes - These taxes are deductible for both first and second homes. 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.
INCOME TAXES
Income taxes are progressive taxes. A progressive tax is one in which the rate increases as the amount to be taxed increases. In other words, the more money a person makes, the higher the taxes will be. The result is that higher income families pay most of the income taxes. On the other hand, some taxes are regressive taxes. A regressive tax is one that uses the same rate regardless of income. A state sales tax is an example of a regressive tax. As we illustrated in our previous examples, a person's income in a given tax year can be substantially higher than normal when a property is sold during that tax year. What can someone do to lessen the impact? Let's find out.
Under what circumstances 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.
Which proposition limited the maximum amount of tax on real property?
Proposition 13
What does Proposition 58 state?
Proposition 58 allows the transfer of property from one spouse to another or to children without triggering a reassessment.
When is real property reassessed?
Real property is reassessed every time it is transferred.
PROPERTY TAXES Senior Citizen's Property Tax Postponement
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 postponement program. Qualifying participants have the option of allowing the state of California 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.
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.
What is important for a broker to remember about the Foreign Investment in Real Property Tax Act?
The buyer is responsible for withholding 15% 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.
When a person acquires new property, which is true?
The owner has 45 days to file a change in ownership statement.
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.
INCOME TAXES Tax-Deferred Exchanges
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, a farm could be exchanged for a store building, vacant land for an apartment building, or a rental home for vacant land.
INCOME TAXES Personal Residence
What happens if a person loses money on the sale of a residence? Can the loss be deducted from income taxes? A loss on a personal residence cannot be deducted from income taxes. 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.
INCOME TAXES Depreciating Income-Producing Property
When depreciating a property, the amount of depreciation must be allocated evenly over the useful life of the property. This is called straight-line depreciation. The depreciation schedule for rented homes and apartments is a minimum of 27.5 years. The schedule for commercial buildings is a minimum of 39 years. For example, let's say an investor owns a single-family residence that he rents out. The home cost $150,000 and the land is worth $30,000, leaving an improvement value of $120,000. If the investor divides the $120,000 by 30 years (the minimum is 27.5), he will have a depreciation figure of $4,000 per year. So he can deduct $4,000 per year for depreciation on this property.
A totally disabled veteran could be eligible for a property tax exemption of up to what amount?
$191,266
PROPERTY TAXES
A city's or county's operating revenue comes mostly from assessing and collecting taxes on real property. The county assessor determines the amount of real property taxes (also called ad valorem taxes) based on the assessed value of the property. The county collector is responsible for collecting these taxes, which are paid annually or semi-annually. Real property is reassessed every time it is transferred. The 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.
INCOME TAXES Tax-Deferred Exchanges
An exchange is simply the trade of one property for another. Commonly referred to as a 1031 exchange after the IRS Code section that defines the parameters, property owners can exchange one investment property for another as long as the transaction qualifies according to the section 1031 guidelines. If the transaction qualifies, the exchange is tax-free. Note: The exchange is not really tax-free; it is tax-deferred. Taxes will be owed at the time the exchanged 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-free exchange could be a viable option.
INCOME TAXES Tax-Deferred Exchanges
An exchange is tax-free if there is a straight trade - 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. Any cash or relief one party receives in addition to the actual property is called boot. The person who receives the boot has a net gain and must pay taxes on it. In a situation like this, the exchange is not fully tax-free, only partially tax-free. Exchanges are particularly popular among investors who own apartment buildings and commercial real estate. Many of these owners are already in high income tax brackets; so exchanging gives them the opportunity to acquire more valuable property without the high tax consequences. They can keep their money invested in real estate holdings by "rolling over" the properties - which mimics selling and buying at the same time.
INCOME TAXES Sale of Real Property
As we mentioned earlier, when a person sells personal real estate, he or she can exclude up to $250,000 if single or $500,000 for a couple that files jointly of the capital gains on that sale. But what happens if the property sells for higher than those amounts? Or what happens when an investor sells property that is not subject to the exclusions mentioned? 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 rate 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.
INCOME TAXES Sale of Real Property - Determining Profit or Loss
Determining the profit or loss on a sale is a three-step process. Calculate what's called the "adjusted cost basis." This is the original purchase price, plus improvements, minus depreciation (not applicable on personal residences). Calculate what's called the "adjusted sale price." This is the sales price minus any sales expenses. Calculate the gain by subtracting the adjusted cost basis from the adjusted sales price. Let's look at a couple of examples. Determining Profit or Loss on a Personal Residence Alan and Amanda purchased a home 20 years ago for $100,000. They have done some recent remodeling that cost another $150,000. They sold their home for $950,000. What is their gain? Cost Basis $100,000 Improvements + 150,000 Adjusted Cost Basis $250,000 Sale Price $950,000 Sales Expenses - 6,500 Adjusted Sales Price $943,500 Adjusted Sales Price $943,500 Adjusted Cost Basis - $250,000 Gain (before exclusion) $693,500 Gain (before exclusion) $693,500 Exclusion - 500,000 Gain (after exclusion) $193,500 Alan and Amanda will have to pay capital gains tax on $193,500.
PROPERTY TAXES Homeowner's Exemption
Every residence that is owner-occupied as of March 1 is eligible to receive a homeowner's exemption of $7,000 of the assessed value. For example, if the Price 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. In order to receive 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 terminates 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 interest plus a 25% penalty.
FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT
In 1985, Congress passed the Foreign Investment in Real Property Tax Act (FIRPTA) 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. In general, FIRPTA 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 (not a US citizen). 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 FIRPTA requirement. Since the broker could be held liable, it's imperative for the broker (or his or her licensee) 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. CAR has a form called the Seller's Affidavit of Nonforeign Status and/or California Withholding Exemption that a seller can sign attesting that he or she is not a nonresident alien. Signing this statement could relieve the broker and buyer of liability for any unpaid taxes. CAR also has a form called a Buyer's Affidavit. This form 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. Both of these 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.
INCOME TAXES Personal Residence - Capital Gains
In addition to the deductions mentioned on the previous screen, a client selling a home has a great tax advantage available. A seller can exclude up to $250,000 of any capital gain on the sale. If the sellers are a married couple that files jointly, they can exclude up to $500,000 in gain. This exclusion can be used once every two years. Even though federal law allows this exclusion every two years, the law states that the seller must have lived in the home for two out of the last five years to qualify for the exclusion. For example, if a client lived in a home for two years, rented it for two more, then sold it, the client would qualify for the $250,000 exclusion. However if the client lived in the home for only one year and then rented it for two more, the client would not qualify for the exclusion unless he or she moved back into the home for another year before selling it.
INCOME TAXES Income-Producing Property
Like homeowners, investors of income-producing property can deduct these three items from their income taxes: Mortgage loan interest - There is no maximum loan amount for investors. Property taxes. Prepayment penalties Unlike owners of personal 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 apartment buildings, commercial buildings and improvements to other investment property, but land cannot be depreciated.
PROPERTY TAXES
Proposition 13 In June 1978, California voters approved Proposition 13. This proposition amended the State Constitution so that the maximum annual tax on real property is limited to one percent (1%) of "full cash value," or market value, plus a maximum two percent (2%) increase in market value per year. For example, Jim and Martha Jones purchased a home last year for $250,000. Their tax bill for last year was $2,500. Assuming an inflation rate 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. In order to understand property taxes in California, it's important to know the order in which taxes are processed. First of all, California uses a system based on the fiscal year rather than the calendar year. The fiscal year starts on July 1 and ends on June 30. Here's how the timetable for taxes works: 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 5 p.m., 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 5 p.m. 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. When a property is sold, the new owner will receive one new property tax bill. However, it takes some time for the tax collector to find out about the sale and then issue a new bill based on the new assessed value. It's important for buyers to understand that they will receive one tax bill, which may be followed by one or more 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 higher valuation for the remainder of the tax year. Here's an example to illustrate. Sally and Dan Beck purchased a home on January 15 for $450,000. Their new property tax will be $4,500. The previous assessment on the home was $150,000; so the previous tax was $1,500 for the fiscal year from July 1 of last year to June 30 of this year. The Becks will receive the "regular" tax bill of $750 for the second installment of the fiscal year taxes due on February 1, which is based on the old assessment. But they actually owe $2,250 (half of $4,500) in taxes on the property they just purchased. Once the county collector reads the county assessor's supplemental tax roll, the Becks will receive a supplemental tax bill of $1,500, which represents the $2,250 they owe less the $750 they paid
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. For example, if a home sold for $175,000 the transfer tax would be $192.50. $175,000 ÷ $500 = 350 x $.55 = $192.50 If a home sold for $280,000 and the buyer assumed the seller's $30,000 loan, the transfer tax would be $275. $280,000 - $30,000 = $250,000 $250,000 ÷ $500 = 500 x $.55 = $275 A city within a county that has adopted a transfer tax can adopt its own transfer tax ordinance. The city's tax amount must be fixed at one-half the rate charged by the county. The county will collect the total tax and then send the city its share.
Proposition 13 Exemptions
Under Proposition 13, a transfer of a property triggers a reassessment. However, there are some circumstances that are exempt from the reassessment: Proposition 58 allows the transfer of property from one spouse to another or to children, without triggering a reassessment. Based on Propositions 60 and 90, homeowners may be permitted to transfer their current Proposition 13 tax base with them if all of the following conditions apply: At least one of the homeowners must be 55 years of age or older. 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). Here's an example to illustrate. Sally and Dan Beck purchased a home on January 15 for $450,000. Their new property tax will be $4,500. The previous assessment on the home was $150,000; so the previous tax was $1,500 for the fiscal year from July 1 of last year to June 30 of this year. The Becks will receive the "regular" tax bill of $750 for the second installment of the fiscal year taxes due on February 1, which is based on the old assessment. But they actually owe $2,250 (half of $4,500) in taxes on the property they just purchased. Once the county collector reads the county assessor's supplemental tax roll, the Becks will receive a supplemental tax bill of $1,500, which represents the $2,250 they owe less the $750 they paid. Change in Ownership Statement Any person who acquires 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 a penalty of $100 or 10% of the taxes applicable to the new valuation, whichever is greater. Exemptions Some properties that are assessed are actually exempt - wholly or in part. All government institutions, some not-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