Thursday, January 13, 2005
Brought to you by the California Association of REALTORS®
TAX LAW CHANGES FOR CAPITAL GAINS AND CALIFORNIA REAL ESTATE WITHHOLDINGS
With the start of a new year, recent changes to real estate tax laws may affect your clients' buying and selling decisions. One significant tax law change involves properties acquired through a 1031 exchange. For these properties, the Internal Revenue Service (IRS) has imposed a five-year ownership requirement for eligibility to the $250,000 (or $500,000 for married couples) exclusion from capital gains taxes. In a separate move, California's Franchise Tax Board has eased its real estate withholding requirements by no longer requiring one as long as a seller's last use of the property being sold was as his or her principal residence.
Here's a hypothetical situation to illustrate how these new rules work. Let's say, in 2001, Tami Taxpayer acquires a rental property through a 1031 exchange, and then, in 2003, she moves into that property as her primary residence. What are the tax consequences if she now sells the property in 2005?
First, even if Tami has lived in the property for two of the last five years, she may not qualify for the $250,000 exclusion from capital gains tax when selling her home. As of October 23, 2004, a taxpayer who acquires property through a 1031 exchange is not eligible for the $250,000/$500,000 exclusion for the first five years of owning that property. Here, Tami is not eligible because she's only owned her property for four years. For more information about this rule, C.A.R.'s Legal Department has recently updated its legal memorandum titled Capital Gains on Real Estate Sales.
Second, despite this potentially onerous tax liability, Tami is exempt from the requirement that 3 1/3 percent of the sales price be withheld from her proceeds. As of January 1, 2005, a new exemption from the California withholding requirement is available for sellers whose last use of the property was their principal residence, regardless of the two-of-last-five-years requirement. For more information, go to C.A.R.'s newly revised legal memorandum titled California Withholding on the Sale of Real Property . In addition, C.A.R's updated standard form "Seller's Affidavit of Nonforeign Status and/or California Withholding Exemption" will be released shortly.
Realegal® is published by the CALIFORNIA ASSOCIATION OF REALTORS®, a trade association representing more than 155,000 REALTORS® statewide.
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