Over the past decade, many states have implemented withholding regimes to collect taxes upfront from property sellers in order to ensure proper payment of state income tax. These withholding programs initially began to make sure out-of-state property sellers met their tax burden in the state where the property was located. States feared that nonresident sellers would simply sell their properties without filing tax returns resulting in lost revenue for the state.
When a taxpayer sells investment and business real estate held for longer than one year, they pay a preferred 15% federal capital gains tax on the profit. Depreciation taken during ownership is recaptured at a 25% rate. States don’t have capital gains taxes and simply tax the sale profit at the appropriate state tax rate.
In general, if a property seller is not recognizing gain at the federal level, such as when a principal residence is being sold or a 1031 exchange is being utilized, the state does not require the closing agent to withhold proceeds from the sale. If no exemption is allowed, then the closing agent will be required to withhold a portion of the sale proceeds, usually determined by multiplying a fixed percentage by the gross sales price or estimated profit, and send the withheld amount to the state’s tax authority.
Possibly due to potential constitutional challenges, some states have programs that apply to all individual property sellers, or conversely, none at all1. The state of California enacted a withholding program that applied to all property sellers, including its own residents. The state of Oregon, on the other hand, stopped its nonresident withholding program a few years ago due to a court challenge by a Colorado resident claiming the program was unconstitutional.2 Nonetheless, in these lean times, many states continue to operate nonresident withholding programs to make sure nonresident property sellers pay their fair share.
The following is a brief description of various state withholding programs (the ones we are aware of) and information on how to obtain an exemption by engaging in a tax deferred exchange. Included is a web-link where further information and/or appropriate forms can be obtained.
A very sophisticated, but fair, withholding program where every individual property seller, including trusts and estates, is required to complete a Form 593C (partnerships, LLCs, and corporations with a permanent place of business in the state are exempt from withholding). The buyer is technically the party required to withhold. However, they can elect to have the closing agent (title or escrow company) withhold on their behalf. This occurs in almost every case.
All sellers doing a 1031 exchange are exempt from withholding, which is 3.33% of the sales price. A seller is also exempt if the property sales price is $100,000 or less. If there is taxable boot in the exchange exceeding $1,500, then 3.33% of the boot is withheld and sent to the state. When there is boot in an exchange or the exchange fails outright, the qualified intermediary is required to withhold and forward the appropriate amount to the State Franchise Tax Board.
Corporations that do not maintain a permanent place of business in Colorado, nonresident individuals, estates and trusts are subject to Colorado income tax withholding on the sales of Colorado real estate in excess of $100,000. The withholding tax, if required, will be the smaller of:
a. 2% of the sales price to the nearest dollar; or
b. the net proceeds from the sale to the nearest dollar.
Taxpayers engaging in a 1031 like kind exchange are exempt from withholding by properly completing Form DR1083. The tax is withheld at the time of closing by the title insurance company, its agent, or any other person providing closing and settlement services. The tax is submitted to the Colorado Department of Revenue, where it will be credited to the seller’s income tax account as an estimated tax payment.
The State of Georgia requires the closing agent to withhold 3% of the sales price for nonresident sellers including individuals, trusts, partnerships, LLCs and corporations.3 Withholding is not required if the sales price is less than $20,000 or the estimated tax liability is less than $600.00. Sellers performing a 1031 exchange and acquiring replacement property in the state of Georgia are exempt by completing Form IT-AFF3. Purchasing property out of state will not allow a waiver of withholding.
Under the Hawaii Real Property Tax Act (“HARPTA”), buyers of Hawaiian real estate from nonresident sellers are required to withhold 5% of the sales price. Nonresident sellers include out-of-state trusts, estates, corporations, partnerships and LLCs. Sellers doing a 1031 tax deferred exchange can provide the buyer with FormN289, which allows an exemption from withholding.
Indiana does not recognize the provisions of IRC §1031 and requires Indiana state income tax to be paid whenever a property is sold for a profit within its borders unless the exchange is a direct transfer (swap) of properties among owners.4
The state requires the buyer of a nonresident’s property to withhold 2 ½% of the sales price of real estate if the price exceeds $50,000. A seller’s exemption must be requested at least two weeks before closing by filing Form REW-5. A 1031 exchange is an allowable exemption. Supporting documentation such as a copy of the exchange agreement may be required.
When a nonresident individual or a nonresident entity is selling property in Maryland, the closing agent must withhold 4.75% of the total payment to a nonresident individual or 7% of the total payment to a nonresident entity. An exemption can be claimed by filing a Form MW506AE with the Comptroller for the State at least 21 days prior to closing. A 1031 exchange is an exempted transaction.
For sales of real estate by nonresident sellers over $100,000, the buyer is required to withhold 5% of the sales price or the net amount realized by the seller, whichever is less.5
If the seller is performing a 1031 exchange, they may provide the buyer with an affidavit signed under penalty of perjury stating no gain is required to be recognized from the sale because of the exchange provided the replacement property is acquired in Mississippi.6
The state requires nonresident individual sellers, estates and trusts to estimate and paytax on their gain from the sale of New Jersey real estate equal to the highest state tax rate of 8.97% but no less than 2% of the gross sales price. Property sellers qualifying for a waiver may file FormGIT/REP-3 to receive an exemption from withholding. The form is attached to the deed as a condition of recording.
New York has a withholding program for nonresident individual sellers, estates and trusts selling property within its boarders. They are required to file Form IT-2663and estimate the amount of tax owed. Taxpayers performing a 1031 tax deferred exchange are exempt from withholding by completing the form and checking box 4B and providing a brief summary of the exchange.
This state requires the buyer of North Carolina property owned by a nonresident individual, partnership, estate, or trust to complete Form NC-1099NRSand file the form with the North Carolina Department of Revenue within fifteen (15) days of the closing date. The form requests basic information such as the parties’ names, addresses, phone numbers and tax identification numbers as well as the closing date and sales price.
The seller is required to file a North Carolina tax return if they are required to recognize gain for federal tax purposes from the sale of North Carolina property. If the seller is performing a 1031 tax deferred exchange, then there should be no requirement for payment of state taxes.
The state of Pennsylvania does not recognize the federal gain deferral rules of IRC§ 1031 and requires the payment of state income taxes realized from the sale of Pennsylvania property.7 For c-corporations, Pennsylvania follows federal tax rules and thus applies section 1031.8 The Pennsylvania personal income tax regime is based on GAAP.
Rhode Island requires the buyer of real property being sold by a nonresident to withhold 6% of the sales price or total gain for individuals, estates, partnerships or trusts and 9% for nonresident corporations.9
If the sale of the property will not be subject to federal tax under IRC §§121 (personal residence sales), 721 (partnership contributions), 1031 (like kind exchanges), or 1033 (involuntary conversions), the nonresident seller must make the gain election and file RI Form 71.3 (Nonresident Election of Gain) and check the box indicating the sale will not be subject to tax because of the exchange. This form must be presented to the buyer prior to closing.
Buyers of South Carolina real estate being sold by nonresidents of the state are required to file Form I-290 and estimate the seller’s gain based on a Seller’s Affidavit submitted to them by the seller using Form I-295. The withholding rates are 7% for individuals and 5% for corporations. The withheld amount is calculated by multiplying the appropriate percentage by the estimated gain (in the case where an affidavit is received) or multiplying the percentage by the sales price when no affidavit is provided.
A nonresident seller can claim an exemption by completing Form I-295 and stating they are not recognizing gain by utilization of a 1031 exchange, sale of a principal residence or 1033 involuntary conversion.
A buyer of Vermont real estate is required to withhold 2 ½% of the sales price when the seller is a nonresident individual, partnership, LLC or corporation. The buyer must complete Form RW-171 and submit it together with the withheld amount to the Vermont Commissioner of Taxes.
A non resident seller can request an exemption from the Commissioner of Taxes stating that no tax would be due because of a 1031 like kind exchange by filing a request for a Withholding Certificate and then presenting the certificate to the buyer prior to closing. The Withholding Certificate is obtained by faxing a copy of Form RW-171 (web link for the form is below), a copy of the exchange agreement, and a copy of the purchase and sale agreement for the targeted replacement property to the Vermont Tax Department. Phone: (802) 828-2777 Fax: (802) 828-2824.
The Vermont Land Gains Tax, a significant tax separate from the regular personal income tax and corporate income tax, by regulation exempts only exchanges of Vermont land for Vermont land.10
Washington state does not impose a personal income tax but it does levy various other taxes. Among these is an excise tax of 1.7% of the sales price paid by the seller of real estate regardless of whether an exchange is being utilized. When a construction or reverse exchange is entered into, the QI/EAT causes a second property transfer to occur which could potentially trigger this additional excise tax. Fortunately, Washington law is quite progressive when it comes to construction and reverse exchange transfers and allows for an exemption from excise tax whenever a QI/EAT transfers replacement property it is holding to the exchangor.11
The sole exception is when an EAT is employed to “park” the relinquished property as part of a reverse exchange (exchange first) structure. An excise tax is always charged on the initial transfer from the exchangor to the EAT. An excise tax is then levied again when the EAT sells the relinquished property to the ultimate buyer, effectively causing the exchangor to pay the tax twice! An exemption from the second excise tax charge can be obtained if the relinquished property is currently under contract with a known buyer at the time the exchangor transfers the relinquished property to the EAT. This is accomplished by having the EAT take title as the buyer’s nominee with both the buyer and EAT executing Real Estate Excise Tax Supplemental Statement (Form REV 84 0002-1 and checking box 5.12 Both signatures will have to be notarized and should be obtained prior to the initial transfer.
Other State Issues
The state of Nevada requires a qualified intermediary (“QI”) to register and post a $50,000 surety bond with the state should they facilitate an exchange where either the relinquished or replacement property is Nevada property or the QI is located or solicits business in Nevada.13
The states of Iowa and South Dakota prevent out-of-state exchange accommodator titleholders (“EATs”) from taking title to certain farmland real estate for the purposes of conducting reverse exchanges.14 These decades-old laws were enacted to prevent large conglomerate farms from buying up all the local farmland from the small farmers. The laws were not intended to make certain tax deferred exchanges virtually unattainable for their citizens. Unfortunately, because of these statutes, nonresident EATs and QIs are unable to facilitate reverse and improvement exchanges in Iowa and South Dakota whenever the property being held by the EAT/QI is Iowa farmland.
1 Privileges and Immunities clause of the United States Constitution, Article IV, Section 2
2 L. McLane and Sue R. Fisher v. Dept. of Revenue, State of Oregon, OTC-MD Case No. 990332C
3 O.C.G.A Section 48-7-128
4 Indiana Code 6-2.1-1-2(c)(15) and 6-2.1-1-2(g).
5 Mississippi Code § 27-7-308. Net amount realized is essentially the net equity in the property.
6 Mississippi Income Tax Regulation §203.
7 Pa. Stat. Ann. tit. 72 §§ 7301(a), 7302, and 7303 (West 2002)
8 Pa. Stat. Ann. tit. 72 §§ 7401(3) and 7402 (West 2002)
9 Rhode Island Regulation NRW 91-01
10 Reg. 1.10005(c)-3.
11 See WAC 458-61-480
12 See WAC 458-61-550
13 Sec. 2. NAC 645.774
14 Iowa Code 2001 Supplement: Section 9H.4 and North Dakota Century Code Chapter 10-06.1