California requires tax to be withheld from the proceeds of the sale of any California real property. Prior to 2007, the amount required to be withheld was 3 1/3% of the total sales price. In many instances, this resulted in withholding more than the seller would actually owe in California income taxes when he prepared his return. About 42% of the total amount collected through the withholding program ended up being refunded to taxpayers. For example, if an individual sells a parcel of California real property for $1,000,000 in which he has an adjusted basis of $800,000, his gain of $200,000 would result in California income taxes of $18,660, at the 9.3% individual income tax rate. However, at the closing of the sale he would have had $33,333 withheld (3 1/3% of $1,000,000) and paid over to the state. He could not get this back until he filed his California income tax return for the year of the sale.
Since January 1, 2007, sellers can elect to have their withholding determined by applying their maximum tax rate to the gain they will realize from the sale. The seller determines his gain by completing Form 593-E and then makes the election to withhold on the actual gain on Form 593-B. It is the buyer’s responsibility to withhold the appropriate amount, but he may delegate this responsibility to the escrow company, which is what typically happens. Each time you sell real property in California, you should calculate the withholding under both methods and use the one that results in the lower amount being withheld.