As you may be aware, the Governor of California recently signed AB 2065, which enacted several changes to California state tax law. Among these changes is a significant revision to Revenue and Taxation Code Section 18662 relating to dispositions of California real property which take place after January 1, 2003. We wanted to alert you to this change and how it will affect sales of real property in California.

As in the case of the rules that apply at the Federal level under the Foreign Investment in Real Property Tax Act (or "FIRPTA"), California Revenue and Taxation Code Section 18662 (which is sometimes referred to as "CalFIRPTA") requires withholding of a percentage of the purchase price from the sale of real estate interests in California in certain circumstances, i.e., generally when the seller is a nonresident individual or a corporation with no permanent place of business in California immediately after the sale. AB 2065 expands these withholding requirements to include individual sellers who are California residents. It should be noted, however, that the withholding requirements imposed by Section 18662 do not apply to foreign corporations that continue to maintain a permanent place of business in California after the sale of an interest in California real estate, and also do not apply to partnerships or limited liability companies. AB 2065 does not affect these exclusions for corporations, partnerships and limited liability companies.

Effective January 1, 2003, for purposes of Section 18662, "individuals," regardless of whether they are residents or nonresidents, will be subject to the CalFIRPTA withholding rules upon the sale of real property in California. Under AB 2065, buyers will be required to withhold 3-1/3% of the sale price unless the sale transaction falls within one of the following categories:

1. the sale price is $100,000 or less;
2. the escrow agent failed to provide written notice of the withholding requirements (a sample form of such notice is set forth in subsection 18668(e)(2) of AB 2065);
3. the property is transferred to a corporate beneficiary by foreclosure or deed in lieu of foreclosure;
4. the buyer relies in good faith on a certificate from the seller that the property being conveyed is the principal residence of the seller;
5. the buyer relies in good faith on a certificate from the seller that the sale is part of a 1031 like kind exchange (pursuant to Section 1031 of the Internal Revenue Code), to the extent such sale qualifies for nonrecognition treatment for California income tax purposes (if the sale fails to qualify for such nonrecognition treatment, the buyer is required to notify the California Franchise Tax Board in writing of such failure to qualify within 10 days of the expiration of specified statutory periods set forth in Section 1031(a)(3) of the Internal Revenue Code);
6. the buyer relies in good faith on a certificate from the seller that the sale is part of a 1033 compulsory or involuntary conversion (pursuant to Section 1033 of the Internal Revenue Code), to the extent such sale qualifies for nonrecognition treatment for California income tax purposes; or
7. the buyer relies in good faith on a certificate from the seller that the sale will result in a loss for California income tax purposes.

It is worth noting that these exemptions are similar to, but differ slightly from, the exemptions which continue to apply (with relatively minor modifications) to dispositions of real property by corporations which do not maintain a permanent place of business in California after the sale. In particular, non-resident corporations will have the right to apply to the Franchise Tax Board for a reduction in the amount required to be withheld so that it approximates the projected amount of tax payable on the sale, whereas individual sellers will not have this right.

The term "sales price" means the sum of the cash paid, plus the fair market value of any other transferred property, plus the outstanding amount of any liability assumed by the buyer (and therefore does not exclude items such as closing costs and transaction expenses). It should also be noted that in the event of an installment sale, the buyer may elect to make the required withholding on a per payment basis, subject to certain requirements relating to the time and manner of payment to be specified by the Franchise Tax Board.

The effect of these changes to CalFIRPTA will likely be an increase in the number of individual real property owners who will be subject to the withholding provisions. It will also mean increased burdens for escrow companies, which are required to deliver written notices of these provisions, and which in most cases will likely take on the obligation of orchestrating the withholding at close of escrow.

Similar to the existing withholding provisions, escrow companies (or other real estate professionals responsible for closing the transaction) cannot charge for their services with respect to this section unless they actively "assist" the parties' compliance with Section 18662 (assistance cannot be simply notifying the parties of the provisions of the Section), and even then can only charge a maximum of $45.

The new provisions enacted by AB 2065 will become effective on January 1, 2003. However, since there is no exemption for transactions already in process on that date, persons entering into real property sales transactions which are not certain to close before the end of 2002 should consider including in the applicable purchase agreement provisions ensuring compliance with the new requirements of AB 2065.

Please let us know if you have any further questions regarding this new legislation, or if we may be of any other service.