Chapter 16: Real Estate Taxation Summary

Property Taxes - assessing and collecting taxes on real property.

The county assessor:

• Determines the amount of real property taxes (ad valorem taxes) based on the assessed value of the property (real property is reassessed every time it is transferred).
• The county collector is responsible for collecting these taxes, which are paid annually or semi-annually. 

Proposition 13 - 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. Proposition 13 Exemptions:

• Proposition 58allows 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 and in the same county. 

The order in which taxes are processed - 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. 

Depending on the timing, a seller may have paid none, half or all of the taxes for the upcoming year. 

Buyers will receive one tax bill, which may be followed by one or more supplemental tax bills. 

Change in Ownership Statement - Any person who acquires property subject to taxes must notify the county recorder by filing a change in ownership statement within 45 days of the date of recording. Otherwise, the owner will pay a penalty. 

Exemptions - All government institutions, some not-for-profit educational entities, many churches and charitable organizations are exempt. Exemptions or other types of relief for:

• Homeowners - Every residence that is owner-occupied as of March 1 is eligible to receive a homeowner's exemption
• Veterans - A California war veteran is eligible to receive exemption against the assessed value of one property.
• Seniors - Persons who are 62 years of age or older and who have a household income of $24,000 or less. 

Special Assessments Tax - levied only once and requires voter approval. 

Documentary Transfer Tax - California tax laws allow a 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. 

Income Taxes

Personal Residence

• Mortgage loan interest- A person can finance up to one million dollars and deduct all of the interest paid out for the year on that loan.
• 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.  

Personal Residence - Capital Gains- 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. The seller must have lived in the home for two out of the last five years to qualify for the exclusion. 

Personal Residence- A loss on a personal residence cannot be deducted from income taxes. If the client turns the property into income-producing property by renting it, then any loss resulting from that sale would be deductible.  

Income-Producing Property - investors of income-producing property can deduct 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 deduct operating expenses and depreciation of improvements - land cannot be depreciated.  

Depreciating Income - Producing Property - the amount of depreciation must be allocated evenly over the useful life of the property - 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. 

Sale of Real Property - Capital gains are taxed at a lower rate than ordinary income. Capital losses can be deducted from capital gains. 

Sale of Real Property - Determining Profit or Loss

• Calculate the "adjusted cost basis" - original purchase price, plus improvements, minus depreciation (not applicable on personal residences).
• Calculate the "adjusted sale price" - sales price minus any sales expenses.
• Calculate the gain by subtracting the adjusted cost basis from the adjusted sales price. 

Income taxes are progressive taxes - the rate increases as the amount to be taxed increases. Some taxes are regressive taxes - uses the same rate regardless of income. 

Installment Sales - the buyer makes payments for a property over more than one calendar year.  

Tax-Deferred Exchanges - An exchange is the trade of one property for another. If the transaction qualifies, the exchange is tax-free. A property that is held for productive use can be exchanged or like-kind property - rentals, commercial/industrial property, land. 

The properties must be "like-kind" in nature or character, not in use, quality or grade. 

Tax-Deferred Exchanges - If the properties are not of equal value, one party may receive cash or mortgage relief to "equalize" the transaction. 

Boot - Any cash or relief one party receives in addition to the actual property. The person who receives the boot has a net gain and must pay taxes on it - only partially tax-free. 

Foreign Investment in Real Property Tax Act (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 of property owned by a foreigner. The IRS keeps this 15% to ensure that any capital gains on the sale are paid. 

Since the broker could be held liable, it's imperative for the broker to:

• Find out the citizenship of all sellersof residential property that is priced at $300,000 or more.
• When taking a listing, require a statement of non-foreign status from the seller. 

CAR has a form called the Seller's Affidavit of Non-foreign 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 which 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. 

If the foreign seller's last known address is outside of California, the buyer may be required to set aside 3.3% of the sales price for the Franchise Tax Board.