The Life of An Escrow

The Life of an Escrow

What is Escrow in California?

Other Parties: In addition to the principals, many other parties may be involved in the escrow. This includes:

  • Real estate brokers and salespeople
  • Attorneys
  • Title Officers
  • Lenders and Mortgage Brokers
  • Termite companies
  • Insurance agents
  • Owners Association and Association Management Companies
  • Government agencies for municipal reports, faxes, liens,
  • Judgments and other monetary or non-monetary encumbrances

The escrow practitioner must be mindful of the confidential nature of the transaction.

For example, the termite company does not need to know the sales price, and an attorney collecting a lien should not be told the amount of the seller's proceeds. Discretion is needed to provide only the information relevant to the particular party, or in providing no information at all when appropriate. In fact, most escrow practitioners should not admit they have an open escrow on a specific property unless they are speaking to the principal, fhe other parties involved in the escrow, or another escrow practitioner with a contingent escrow.

The Life of an Escrow

Licensed vs Unlicensed "Controlled"

All escrow companies in California can be classified into two basic categories: Licensed or Controlled. "Licensed" escrow companies are independent businesses licensed by the California Department of Business Oversight. This license regulates the procedures and practices of the companies and subjects them to stringent requirements designed to protect consumers.

"Controlled" escrow companies are non-licensed businesses that can be owned by a variety of entities, including real estate brokers, mortgage brokers, banks, savings and loans, and title insurance companies. Such companies fall under the jurisdiction of a variety of supervising agencies, with regulations and requirements that vary widely. One fact remains constant, however. None of the agencies have regulations as strict as those imposed on the escrow companies licensed by the Department of Business Oversight.

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Better Protection

Although the majority of escrow companies are honest and above board, the large sums of money handled by escrow companies can entice unscrupulous individuals to abscond with the funds they are holding in trust. Ang unless the escrow company is bonded, there is often no safeguard assuring the return of the money to consumers.

Licensed escrow companies are consumers' best bet for safeguarding their gunds. All licensed escrow companies are required to be members of the Escrow Agents' Fidelity Corporation (EAFC), which provides fidelity coverage for member trust accounts.

Higher Standards

The stringent requirements by the Department of Business Oversight assure that every licensed escrow company has met the highest standards in the industry. Consumer protection regulations unique to licensed escrow companies include:

  • A Certification Program for all escrow officers in the company's employ, including fingerprinting and background checks by the Department of Justice;
  • A requirement that an escrow officer with at least five years of experience be on-site;
  • Financial stability requirement, including at a minimum one CPA audit a year; and, frequent surprise examinations conducted by the Department of Business Oversight;
  • Prohibiting employment of convicted felons or anyone who has been disbarred from the real estate industry;
  • Membership with the Escrow Agents' Fidelity Corporation (EAFC) which provides fidelity coverage for member trust accounts;
  • The company's sole business is doing escrow, which requires a higher level of state regulatory requirements and oversight.

The bottom line is that a licensed escrow company is the best possible neutral third party to complete your real estate transaction. Whether searching for an escrow holder yourself or looking to recommend one to a client, a licensed escrow company gives you peace of mind.

The Life of an Escrow
The Life of an Escrow

Understanding Required Reporting to the IRS

Sellers of real property will have certain information regarding the sale reported to the Internal Revenue Service (IRS). This required reporting of information is a consequence of the Tax Reform Act of 1986; it is intended to encourage taxpayer compliance with the internal Revenue Code and aid in audit and enforcement efforts by the IRS.

To help you better understand this subject, the California Land Title Association has answered some of the questions most commonly asked about required reporting to the IRS.

Who is required to report to the IRS?

Sellers of real property, under guidelines established by the IRS, are required to have the dollar amount of their gross proceeds from the sale reported on a Form 1099S. When a settlement agent is used, the IRS makes the settlement agent responsible for the delivery of the seller's gross proceeds information on the Form 1099S.

The settlement agent generally will be the escrow agent or title company; however, it may be an attorney, real estate broker or other person providing settlement services.

The Life of an Escrow
The Life of an Escrow

What is an IRS Form 1099S; and what will be reported?

The Form 1099S is the reporting form adopted by the IRS for submitting the seller's gross proceeds information required by law.

The Information is transferred onto magnetic media by the settlement agent who will make the required report to the IRS The settlement agent is also required to keep a master copy of all transactions reported for a length of four years from the date of transaction.

In general, information required by the IRS falls into the following categories:

  1. The name, address, and taxpayer ID number (social security or tax identification number, often called the ("TIN") of the seller(s))
  2. A general description of the property (in most cases, an address)
  3. The closing date of the transaction
  4. The gross proceeds of the transaction (even though gross proceeds do not correspond to taxable income)
  5. Any property involved as part of the transaction other than cash or cash equivalent
  6. The name, address, and taxpayer identification number of the settlement agent
  7. Real estate tax paid in advance that is allocable to the buyer
The Life of an Escrow
The Life of an Escrow

Currently, typical homeowner transactions covered include sales and exchanges of 1-4 family residential properties such as houses and condominiums. Also reportable are sales or exchanges of improved or unimproved land, commercial or industrial buildings, condominiums, stock in a cooperative housing corporation, and mobile homes manufactured homes) affixed to real property.

Specifically excluded from reporting are (a) foreclosures (b) abandonments of real property and (c) financings or refinancing of properties. additionally, a form10995 is not required for the sale or exchange of a principal residence with gross proceeds of $250,000 or less ($500,000 or less for married filing jointly) if an acceptable written assurance certification) from the seller is obtained that indicates the full gain is excludable from the seller's gross income.

Understanding Required Reporting to the IRS

Continues..

What happens if the seller(s) refuses to provide the taxpayer identification number for Form 1099S?

The settlement agent is required to request the transferor's taxpayer identification number(s) (TIN(s)) before the time of closing. You may request a TIN on Form W-9 or use an alternative written request RS has included sample wording of an alternative written request in the instrUctions for the preparation n of Form 1099S.

Should the seller fail to provide the identification number and certify its correctness, the settlement agent may choose to:

1. Delay the closing of the transactions until the information is furnished, or

2. Complete the transaction and report to the I.R.S. that an attempt was made to obtain the information from the seller.

How is the sale reported when there is more than one seller involved or when multiple sellers do not own equal interests in the property?

Multiple sellers may allocate the gross proceeds among themselves for purposes of reporting. If there is no allocation, an incomplete allocation, or conflicting allocations, then the entire gross proceeds will be reported for each seller.

Foreign Investment in Real Property Tax Act of 1980 or FIRPTA

The Disposition of a U.S. real property interest by a foreign person (the transferor) is subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding.

FIRPTA authorized the United States to tax foreign persons on dispositions of U.S. real property interests. A disposition means "disposition" for any purpose of the Internal Revenue Code. This includes but is not limited to a sale or exchange, liquidation, redemption, gift, transfers, etc. Persons purchasing U.S. real porperty interests (transferees) from foreign persons, certain purchasers' agents, and settle officers are required to withhold 10 percent of the amount realized on the disposition (special rules for foreign corporations).

In most cases, the transferee/buyers is the withholding agent. If you are the transferee/buyer you must find out it the transferor is a foreign person. If the transferor is a foreign person and you fail to withhold, you may be held liable for the tax. For cases in which a U.S. business entity such as a corporation or partnership disposes of a U.S. real property interest, the business entity itself is the withholding agent.

The Life of an Escrow
The Life of an Escrow

Tax Implications of Selling a U.S. House for Non-Resident Aliens

General Rule

The IRS requires the purchaser must withhold 10% of the sales price for the IRS; 3.3% of the sales price for California Tare taxes. The purchaser is personally liable for a failure to withhold.

Note 1: The IRS may fake between 8 to 12 weeks to return an approved withholding certificate. Submit with the Form 8288-8 well in advance of the sale's closing. MUST GET TAXPAYER ID NUMBER FOR FEDERAL & CALIFORNIA.

Note 2: Submit a Form W-7 (request for taxpayer ID number) with the Form 8288-B, IRS is unlikely to issue a Taxpayer ID Number before submitting the Form 8288-B or completing the Form 1040NR

Note 3: The purchaser need only pay to the IRS the revised withholding amount by the 20th day after the Service mails a copy of the withholding certificate, whether approved or denied.

Exceptions to Withholding Requirement for Non-resident Aliens

The Buyer of a US Property does not have to withhold Federal Taxes if: The purchase price is no more than $300,000 and the buyer has definite plans to reside in the property at least 50% of the time in the next 2 years. (i.e. not a rental property).

Note:
What is an "amount realized" for this purpose? The cash paid, or to be paid;
The fair market value of the property transferred, or to be transferred, and
The outstanding amount of any liability assumed by the transferee

The Life of an Escrow

Procurring a Individual Taxpayer Id Number (ITIN)

1. What evidence must you submit to the IRS?

(a) an original passport or (b) a certified copy of the passport.

2. What is a certified copy of the passport?

A copy certified by the non-resident alien's home country's consulate.

3. When will the IRS issue a Taxpayer ID number?

A taxpayer ID number will be issued only upon the occurrence of certain events such as:

A. If they are completing an IRS Form 1040NR (the year after the sale of the house). They must attach the taxpayer return with the Form W-7,
B. If they are attempting to avoid mandatory withholding on a rental property or the sale of a property. Seller should attach to the Form W-7: A completed Form 8288-5B, and A copy of the sales contract (also, copies of Forms 8288 and 8288-A submitted by the buyer should be attached to Form W-7).

4. Where do you send the Form IRS W-7? (ITIN approximately takes anywhere from 5 weeks to 3 months to be assigned)

Mail it to the following address:
Internal Revenue Service ITIN Operation
P.O. Box 149342, Austin, TX 78714-9342
Note: Taxpayer ID numbers are only good for 5 years.

Understanding Living Trusts

Estate planners often recommend "Living Trusts" as a viable option when contemplating the manner in which to hold title. When a property is held in a Living Trust, title companies have particular requirements to facilitate the transaction.

Who are the parties to a trust?

A typical trust is the Family Trust in which the Husband and Wife are the Trustees and, with their children, the beneficiaries. Those who establish the trust and transfer their property into it are known as Trustors. After their passing, their children and grandchildren usually become the primary beneficiaries if the trust is to survive, or the beneficiaries receive distributions directly from the trust if it is to close out.

What is a Living Trust?

Sometimes called an Inter-vivos Trust, the living trust is created during the lifetime of the Trustor (as opposed to being created by their Will after death) and usually terminates after they die and the body of the Trust is distributed to their beneficiaries.

Can a Trust hold title to Real Property?

No. The Trustee holds the property on behalf of the Trust.

Is a Trust the best way to hold my property?

Only your attorney or accountant can answer the question; some common reasons for holding property in a Trust are to minimize or postpone death taxes, avoid time-consuming probate, and shield property from attack by certain unsecured creditors.

What taxes can I avoid by putting my property in a Trust?

Married persons can usually exempt a significant part of their assets from taxation and may postpone faxes after the first of them to die passes. You should check with your attorney or accountant before taking any action.

Can someone else hold title for me "In Trust"?

Some people who do not wish their names to show as titleholders make private arrangements with a hird party Trustee; however, sUch an arrangement may be illegal and is always inadvisable because the trustee of the record is the only one who is empowered to convey or borrow against, the property, and the me Insurer cannot protect you from a Trustee who is not acting in accordance with your wishes despite no existence of a private agreement you have with the Trustee.

Understanding Supplemental Taxes

State law requires the Assessor to reappraise property upon a change in ownership or completion of new construction. The Supplemental assessment reflects the difference between the new value and the old value. The Auditor-Controller calculates the supplemental property fax, and prorates it, based on the number of months remaining in the fiscal year in which the event occurred. The fiscal year runs from July 1 through June 30.

A change in ownership or new construction completion which occurs between January 1 and May 31 results in two supplemental assessments and two supplemental tax bills. The first supplemental bill is for the remainder of the fiscal year in which the event occurred. The second supplemental bill is for the subsequent fiscal year.

Notices of Assessed Value Change are mailed to property owners before supplemental tax bills are issued.

Remember that supplemental tax bills are in addition to the regular annual tax bills. Supplemental bills go directly to the property owner, and not to an impound account- where one might exist.

The Life of an Escrow
The Life of an Escrow

When Did This Tax Come Into Effect?

The Supplemental Real Property Tax Law was signed by the Governor in July of 1983 and is part of an ambitious drive to aid California's schools. This property tax revision is expected to produce over $300 million per year in revenue for schools.

Can You Give Me an Idea of How the Proration Factor Works?

The supplemental tax becomes effective on the first day of the month following the month in which the change of ownership or completion of new construction occurs. If the effective date is July 1st, then there will be no supplemental assessment on the current tax roll and the entire supplemental assessment will be made to the tax roll being prepared which will then reflect the full cash value. In the event the effective date is not July 1st, then a table of factors would be Used to compute the supplemental assessment on the current tax roll.

Where can I find out how much I may owe for Supplemental Tax?

Please visit http://assessor.lacounty.gov/supplemental-tax-estimator/ Simply enter your property address or your 10-digit Assessor Identification Number (AIN)

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California Tax Calendar

January 1

Assessment Date

April 10

Tax Bills Due
Secured - 2nd half installment
(where it applies)

June - August

Value Notices Issued

August 31

Tax Bills Due
Unsecured - Or 60 days after
issued if after 8/31

September 15-November 30

Appeal Deadline
For Most Counties, if value
notices issued after August 1

December 10

Tax Bills Due
Secured-1st half installment

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