Chapter 10TaxationReal Estate-Related Taxes

I. Real Property Taxes

Real Property Taxes A city or county receives most of its operating

revenue from the assessment and collections of real property taxes

REAL PROPERTY TAXES are determined according to the value of the real property, and are paid annually or semi-annually

These taxes are called AD VALOREM TAXES which are charged in proportion to the value of the property

A. Proposition 13

Prop 13 surprised the nation by rolling back the California property tax to 1 percent of the owner’s value, making it the lowest rate in the country

A “rough” estimate of property tax is approximately 1.25 percent of the sales price

Transfers of ownership can trigger reassessment

Propositions 58, 60, and 90 have created several changes to Prop 13

B. Property Taxes Become A Specific Lien

Property taxes are, in effect, liens against a specific property

Property taxes for the following fiscal year become a lien against the real property on January 1 of the current year

C. Property Tax Time Table Important tax dates can be remembered “No Darn

Fooling Around” as follows:

N November 1 (first installment due)D December 10 (first installment is delinquent)F February 1 (second installment due)A April 10 (second installment is delinquent)

D. Property Tax Proration Problem

E. Homeowner’s Property Tax Exemption

Homeowner’s property tax exemption is $7,000 of assessed valuation

The HOMEOWNER’S PROPERTY TAX EXEMPTION is a deduction on the property tax bill of the first $7,000 of assessed value of an owner-occupied property

F. Disabled & Senior Citizens Property Tax Postponement Seniors who are 62 years of age or older and have a

household income of $24,000 or less may qualify for this tax postponement assistance program

This program offers them the option of having the state pay all or part of the taxes on their homes

In return, a lien is place on the home for the amount that the state has to pay

G. Veteran’s Exemption Any California resident who served in the military

during a time of war is entitled to an annual $4,000 property tax exemption against the assessed value of one property

This exemption also applies to the widow, widowed mother, or pensioned father of a deceased veteran

For disabled California veterans who qualify, the assessment limit can be raised up to $100,000

H. Tax Exempt Property Some properties are partially or totally tax exempt

All real property owned by the federal, state, county, or city government is automatically tax exempt

45% of California is federally owned since it has many national and state parks

Property of non-profit organizations used for religious, charitable, medical, or educational purposes is also tax exempt

II. Special Assessment Tax

Special Assessment Tax A SPECIAL ASSESSMENT TAX is levied by a city

council or a county board of supervisors, with the voters’ approval, for the cost of specific local improvements such as streets, sewers, irrigation, or drainage

Assessments are different from property taxes in that they are levied once for a particular work or improvement

A. Improvement Bond Act of 1915

The IMPROVEMENT BOND ACT OF 1915 finances street and highway improvements through as assessment to property owners based upon the frontage of property facing the improved street

Through the issuance of municipal bonds, it allows property owners up to 30 years to pay off their portion of the improvement assessment

B. Mello-Roos Community Facilities Act

The Mello-Roos Community Facilities Act is another type of improvement bond

III. Documentary Transfer Tax

Documentary Transfer Tax Documentary transfer taxes are paid only on the

new amount of money (cash down and new financing), not on any assumed financing

The DOCUMENTARY TRANSFER TAX is a tax that is applied to the consideration paid or money borrowed when transferring property, except for any remaining loans or liens on the property

The tax is computed at the rate of 55¢ for each $500 or $1.10 per $1,000 of consideration or any fraction thereof

IV. Gift and Estate Taxes

A. Federal Gift Taxes

Both a husband and wife may now give away $5.34 million each over a lifetime without paying any gift tax

A DONOR is the person giving the property as a gift

The DONEE is the person receiving the gift

B. Federal Estate Tax

A FEDERAL ESTATE TAX return must be filed for the estate of every resident of the United States whose gross estate exceeds $2,000,000 in value at the date of death as of 2008, and $3,500,000 as of 2009

C. No State Gift & Inheritance Taxes

In 1982, California repealed both the state Gift and Inheritance taxes.

V. Federal & State Income Taxes

California has both state and federal income taxes,

making us among the most taxed people in the United States

VI. Taxes on Personal Residence

A. Deduction of Interest

Deduction of interest on your home loan from your income taxes is one of the major tax advantages of owning real estate

B. Deduction of Property Taxes

Property taxes on your 1st and 2nd homes are deductible from your income taxes

C. Deduction of Prepayment Penalties

Prepayment penalties can also be deducted from your income taxes

D. Sale of A Residence

The capital gains exclusion is by far your best tax benefit of home ownership

Federal laws allow a taxpayer to exclude up to $250,000 of gain for each individual ($500,000 for a married couple)

This benefit can only be used once every 2 years for a residence

VII. Taxes for Income Producing Properties

Investors can deduct:

• Mortgage interest on loans• Property taxes• Prepayment penalties• Operating expenses• Depreciation of Improvement

A. Depreciation of Business Property

DEPRECIATION FOR TAX PURPOSES is a yearly tax deduction for wear and tear on improved investment property that is deducted from the taxpayer’s income on his or her income tax form

Only buildings and other improvements can be depreciated, not the land

Residential properties can be depreciated for 27.5 years (straight line)

Commercial properties 39 years (straight line)

B. Advantages of “Sale-Leaseback”

If the owner of a business sells his or her building for cash, and then leases it back, the seller becomes a lessee and the buyer the lessor

The advantage to the seller is all lease payments can be deducted from income taxes and he receives cash for the building

The advantage to the buyer is he can use the purchase price as the new basis for depreciation and establish a new depreciation schedule

VIII. Sale of Real Property

A. Capital Assets

In real estate, a capital asset includes a personal residence and any other real estate, because they are long-term investments

CAPITAL GAINS are taxes at a lower rate than ordinary income

CAPITAL LOSSES can be deducted from capital gains

B. Californians Pay Both State and Federal Income Taxes

All gains for Individual income tax are as high as 13.3% in California

Our state has the highest top marginal “Capital Gains” tax rate -33.3% combined

C. Federal Income Tax Rates Income tax rates are progressive

PROGRESSIVE TAXES are taxes where the rates increase as the amount to be taxed increases, the more you make, the more you pay

MARGINAL TAX RATE is the rate that the next dollar earned puts you into

REGRESSIVE TAXES use the same rate no matter how much you make, for example sales tax is a regressive tax

D. Alternative Minimum Tax The ALTERNATIVE MINIMUM TAX requires

taxpayers, who make above a certain amount of gross income, to figure their taxes twice

They first do their taxes using the actual itemized deductions method

Then figure them using the AMT rate and pay whichever tax is higher

E. Accounting for the Sale of Real Estate

The IRS has specific methods for determining a profit or loss from the sale of real estate:

IX. Installment Sales and Exchanges

A. Installment Sales of Real Estate

An INSTALLMENT SALE is the sale of real estate in which the payments for the property extend over more than one calendar year

Installment sales are used because a gain is only taxed in the year that it is received, spreading the gain over several years

B. Exchanges Tax-Deferred

Simultaneous 1031 Exchanges

Starker Delayed Exchange

Reverse 1031 Exchanges

X. Dealer Property

Dealer Property

DEALER PROPERTY is the inventory of properties held primarily for sale to customers

Dealer properties do not qualify for tax-free exchanges

XI. We Are Now Tax Collectors

A. Federal Tax Collection Requirements

When dealing with foreign investors, the buyer is required to set aside 10 percent of the purchase price for the IRS

If this amount is NOT set aside, the broker may be liable for the full amount of the tax not paid

B. State Tax Collection Requirement and Exemptions

The state requires 3.3% of the sales price to be set aside from Foreign Investors for the Franchise Tax Board

The exemptions from the buyer withholding 3.3% of the sales price for the Franchise Tax Board are :

Sales price is $100,000 or less Property is seller’s principal residence, under certain conditions Seller signs California Residency Declaration Seller receives a waiver – Franchise Tax Board Form 593-C

XII. Other Taxes Paid by Brokers

A. Business License Taxes

A city may levy a tax against real estate brokerage firms, which is based upon the gross receipts, through a BUSINESS LICENSE TAX

Chapter Summary• Property Taxes• Proposition 13• Specific lien• Time Table• Homeowner’s Tax Exemption• Disabled/Senior Tax

Postponement• Tax Exempt Properties

• Special Assessment Tax• Improvement Bond Act of 1915• Mello-Roos

• Documentary Transfer Tax

• Gift and Estate Taxes• Federal Gift Taxes• Federal Estate Tax• No State Gift/Estate taxes

• Federal & State Income Taxes

• Taxes on Personal Residence• Deduction of interest• Deduction of property taxes• Deduction of prepayment penalties• Sale of a Residence

Chapter Summary• Taxes for Income Producing

Properties• Depreciation of Business Property• Advantages of “Sale-Leaseback”

• Sale of Real Property• Capital Assets• Federal Income Tax Rates• AMT• Accounting for Sale of Investment

Property

• Installment Sales & Exchanges• Installment sales of real estate• Exchanges tax-deferred

• Dealer Property

• We Are Now Tax Collectors• Foreign investors

• Other Taxes Paid by Brokers• Business License