California taxes on out-of-state property captial gains

[sierras]

In 2006 I sold a vacation property in AZ and paid AZ state capital
gains taxes on it. Now California says they are also owed capital
gains on it. Do I have to pay both? That sounds like double taxation.
Thanks. Keith

========================================= MODERATOR'S COMMENT:
Please tell us the state in which you reside? Do you file a
resident tax return in CA?

 

[removeps-groups]

In 2006 I sold a vacation property in AZ and paid AZ state capital
gains taxes on it. Now California says they are also owed capital
gains on it. Do I have to pay both? That sounds like double taxation.
Thanks. Keith

========================================= MODERATOR'S COMMENT:
Please tell us the state in which you reside?  Do you file a
resident tax return in CA?

Right. If you are a resident of CA, you have to pay CA tax on your
worldwide income. However, you get a credit for taxes paid to AZ on
the AZ source income. So there's no double tax, just higher tax in
most cases .

If you used the home as your primary residence in 2 of the last 5
years then you can claim the housing exclusion. CA allows this
exclusion as well; I don't know about AZ. There are restrictions on
the exemption when a personal residence is converted to a rental, or
the other way, I can't remember which.

 

[Mark Bole]

Right. If you are a resident of CA, you have to pay CA tax on your
worldwide income. However, you get a credit for taxes paid to AZ on
the AZ source income. So there's no double tax, just higher tax in
most cases .

California has no special tax rate for capital gains, it is all ordinary
income.

The AZ "other state tax credit" for a California resident is not claimed
on the CA Schedule S; for AZ (and a handful of other states), you claim
the "other state tax credit" on the other state non-resident return.

If you used the home as your primary residence in 2 of the last 5
years then you can claim the housing exclusion. CA allows this
exclusion as well; I don't know about AZ. There are restrictions on
the exemption when a personal residence is converted to a rental, or
the other way, I can't remember which.

Except for grand-fathered periods of use before 2009, the "restriction"
(pro-rated exclusion) applies when a rental is converted to a primary
residence. You can still convert a primary residence to a rental for up
to three years and get the full 2-out-of-5 exclusion amount.

-Mark Bole

 

[removeps-groups]

California has no special tax rate for capital gains, it is all ordinary
income.

True, but the original post did not ask about this.

The AZ "other state tax credit" for a California resident is not claimed
on the CA Schedule S; for AZ (and a handful of other states), you claim
the "other state tax credit" on the other state non-resident return.

I'm confused. Suppose the original poster is a CA resident. Suppose
the CA marginal tax rate is 10% and AZ is 2.5%. Suppose the profit is
10k. There are 2 ways.

(1) Since this is AZ real property, AZ gets 2.5% of 10k or $250. In
fact, they might impose witholding on the sale of the property -- at
least CA does this for nonresidents. CA taxes 10% of 10k or $1000
minus the credit paid to AZ, so net to CA is $750.

(2) Since the person is a CA resident, CA first gets their $1000. AZ
tax is $250 but minus the $1000 paid to CA, the net AZ tax is $0.

In both cases the person pays $1000, but each method pays to different
states. I'm sure the states have a rule they follow. From what you
wrote above it seems like you're saying it is method (2). Where is
this in the rules?

 

[Mark Bole]

True, but the original post did not ask about this.

"State Capital Gains Taxes" [from OP]. The OP didn't ask about a
Section 121 exclusion on his primary residence either, but you included
that in your reply. In fact, you frequently toss in extra info in your
replies in this newsgroup, but I'm not complaining -- it's part of what
the newsgroup is about, exchanging ideas and information.

I'm confused. Suppose the original poster is a CA resident. Suppose
the CA marginal tax rate is 10% and AZ is 2.5%. Suppose the profit is
10k. There are 2 ways.

(1) Since this is AZ real property, AZ gets 2.5% of 10k or $250. In
fact, they might impose witholding on the sale of the property -- at
least CA does this for nonresidents. CA taxes 10% of 10k or $1000
minus the credit paid to AZ, so net to CA is $750.

If this were most other states, CA Schedule S for residents has you
calculate the CA tax on the double-taxed income, the other state tax on
the double-taxed income, and then you get a credit for the smaller of
those two amounts.

The tax computation is not based on marginal rate, but is each state's
total tax liability multiplied by the ratio of double-taxed income to
AGI for each state. In other words, if the double-taxed income was 50%
of your total AGI for a given state, then the amount used on Schedule S
is 50% of your total tax liability for that state.

I don't see what withholding has to do with it, but see comment above.

(2) Since the person is a CA resident, CA first gets their $1000. AZ
tax is $250 but minus the $1000 paid to CA, the net AZ tax is $0.

In both cases the person pays $1000, but each method pays to different
states. I'm sure the states have a rule they follow. From what you
wrote above it seems like you're saying it is method (2). Where is
this in the rules?

See the instructions for CA Schedule S ("No credit is allowed if the
other state allows residents a credit for net income taxes paid to
California") and AZ Form 309.

-Mark Bole

 

[Katie]

True, but the original post did not ask about this.


I'm confused.  Suppose the original poster is a CA resident.  Suppose
the CA marginal tax rate is 10% and AZ is 2.5%.  Suppose the profit is
10k.  There are 2 ways.

(1) Since this is AZ real property, AZ gets 2.5% of 10k or $250.  In
fact, they might impose witholding on the sale of the property -- at
least CA does this for nonresidents.  CA taxes 10% of 10k or $1000
minus the credit paid to AZ, so net to CA is $750.

(2) Since the person is a CA resident, CA first gets their $1000.  AZ
tax is $250 but minus the $1000 paid to CA, the net AZ tax is $0.

In both cases the person pays $1000, but each method pays to different
states.  I'm sure the states have a rule they follow.  From what you
wrote above it seems like you're saying it is method (2).  Where is
this in the rules?

--

A little further explanation:

In general, states tax their residents on all income, regardless of
its source. States also tax nonresidents on income from sources
within the state. As a result, if you are a resident of State A and
have income from a source in State B, both State A and State B will
tax that income. (Of course there are exceptions; some states have no
individual income taxes, and a few states exempt a resident's business
income from out-of-state sources.)

The resulting double taxation may be mitigated by a credit granted by
one state for the tax paid to the other, or by a reciprocal agreement
between two states. Reciprocal agreements generally apply only to
income from employment (wages), so that a resident of one state
working in the other pays tax on his or her earnings only to the state
of residence. Thus the source state cedes the tax to the residence
state. California has no reciprocal agreement with any other state.

Credits for taxes paid to other states generally are allowed to
residents of the state granting the credit. As a rule the credit is
limited to the lesser of (a) the tax actually paid to the source state
or (b) the proportion of the resident state tax liability that relates
to the "double taxed" income. As a result the taxpayer's total net
state income tax on that income is at the higher of the two states'
average rates for that taxpayer's filing status, income level, number
of dependents, etc. When the residence state grants the credit it is
in effect cediing the tax to the source state -- the source state
keeps the money.

A few states stand in a reverse credit relationship whereby the source
state grants a credit for the tax paid to the state of residence.
Arizona, Indiana, Virginia, Oregon, and California have such a reverse
credit relationship with one another. Thus a resident of one of those
states with income sourced in another of them looks to the source
state for a credit for the tax paid to the residence state. In this
case the source state is ceding the tax to the residence state.
Again, the credit is limited to the lesser of (a) the actual tax
liability to the source state or (b) the proportion of the residence
state tax liability that relates to that income, and the net state tax
on the "double taxed" income is at the higher of the two states'
average rates applicable to that taxpayer.

The OP in this thread must pay California tax on the gain on the sale
of his Arizona property, and file an amended return with Arizona to
claim credit for the California tax (assuming the statute of
limitations on the AZ return is still open).

Note that the credit and reciprocal agreement mechanisms that mitigate
(but do not always eliminate) the double taxation of income appear to
be a matter of legislative grace. They are not required by any
constitutional or federal statutory provision. Sometimes credits are
not allowed. For example, many states allow credit for tax paid to
another state only if the tax was paid in the same year; if an item of
income was taxed in one year by State A and in a different year by
State B, no credit may be allowed. Also, many states limit the credit
to taxes paid to the other state on income FROM SOURCES WITHIN THAT
STATE -- and states differ in their definitions of source income. For
example, if you are a California resident and sell real property in
Massachusetts on an installment basis, Massachusetts will tax both the
gain element and the interest income that you receive on the
installment note, because both are considered Massachusetts source
income. California will give you credit for the tax you pay to
Massachusetts on the gain element, because that is Massachusetts
source income by California's lights; but California will not allow
credit for the tax paid to Massachusetts on the interest, because by
California's lights that is income from an intangible (the note) and
is sourced at your residence -- California.

Katie in San Diego

 

[removeps-groups]

A little further explanation:

In general, states tax their residents on all income, regardless of
its source.  States also tax nonresidents on income from sources
within the state.  As a result, if you are a resident of State A and
have income from a source in State B, both State A and State B will
tax that income.  (Of course there are exceptions; some states have no
individual income taxes, and a few states exempt a resident's business
income from out-of-state sources.)

The resulting double taxation may be mitigated by a credit granted by
one state for the tax paid to the other, or by a reciprocal agreement
between two states.  Reciprocal agreements generally apply only to
income from employment (wages), so that a resident of one state
working in the other pays tax on his or her earnings only to the state
of residence.  Thus the source state cedes the tax to the residence
state.  California has no reciprocal agreement with any other state.

Credits for taxes paid to other states generally are allowed to
residents of the state granting the credit.  As a rule the credit is
limited to the lesser of (a) the tax actually paid to the source state
or (b) the proportion of the resident state tax liability that relates
to the "double taxed" income.  As a result the taxpayer's total net
state income tax on that income is at the higher of the two states'
average rates for that taxpayer's filing status, income level, number
of dependents, etc.  When the residence state grants the credit it is
in effect cediing the tax to the source state -- the source state
keeps the money.

A few states stand in a reverse credit relationship whereby the source
state grants a credit for the tax paid to the state of residence.
Arizona, Indiana, Virginia, Oregon, and California have such a reverse
credit relationship with one another.  Thus a resident of one of those
states with income sourced in another of them looks to the source
state for a credit for the tax paid to the residence state.  In this
case the source state is ceding the tax to the residence state.
Again, the credit is limited to the lesser of (a) the actual tax
liability to the source state or (b) the proportion of the residence
state tax liability that relates to that income, and the net state tax
on the "double taxed" income is at the higher of the two states'
average rates applicable to that taxpayer.

So if the rental property was in another state like HI, then HI would
tax the capital gain, and CA give a credit for tax paid to HI? But as
the property is in AZ, AZ gives a credit for tax paid to CA.

How did such an agreement come about? It seems to favor states with
high tax rates. If an AZ resident sells their CA home, they get a
credit on their CA tax return for taxes paid to AZ, but as CA tax
rates are higher, CA still gets a good bit of money on the sale. In
this case, AZ will get $0.

The OP in this thread must pay California tax on the gain on the sale
of his Arizona property, and file an amended return with Arizona to
claim credit for the California tax (assuming the statute of
limitations on the AZ return is still open).

The statute of limitations to file an amended state return is 4 years,
not 3, so maybe the original poster will still be lucky. However,
I've read on this newsgroup that many states are not paying interest
on refunds.

Note that the credit and reciprocal agreement mechanisms that mitigate
(but do not always eliminate) the double taxation of income appear to
be a matter of legislative grace.  They are not required by any
constitutional or federal statutory provision.  Sometimes credits are
not allowed.  For example, many states allow credit for tax paid to
another state only if the tax was paid in the same year; if an item of
income was taxed in one year by State A and in a different year by
State B, no credit may be allowed.  Also, many states limit the credit
to taxes paid to the other state on income FROM SOURCES WITHIN THAT
STATE -- and states differ in their definitions of source income.  For
example, if you are a California resident and sell real property in
Massachusetts on an installment basis, Massachusetts will tax both the
gain element and the interest income that you receive on the
installment note, because both are considered Massachusetts source
income.  California will give you credit for the tax you pay to
Massachusetts on the gain element, because that is Massachusetts
source income by California's lights; but California will not allow
credit for the tax paid to Massachusetts on the interest, because by
California's lights that is income from an intangible (the note) and
is sourced at your residence -- California.

Thanks for all the detailed information.

 

[Katie]

snip


So if the rental property was in another state like HI, then HI would
tax the capital gain, and CA give a credit for tax paid to HI?  But as
the property is in AZ, AZ gives a credit for tax paid to CA.

How did such an agreement come about?  It seems to favor states with
high tax rates.  If an AZ resident sells their CA home, they get a
credit on their CA tax return for taxes paid to AZ, but as CA tax
rates are higher, CA still gets a good bit of money on the sale.  In
this case, AZ will get $0.

Reciprocal agreements with regard to wages earned by nonresidents are
negotiated between the states involved. Illinois once had such an
agreement with Indiana, but Illinois decided it was getting the short
end of that stick (i.e., there were more Indiana residents working in
Illinois than vice versa) and asked Indiana to pay an annual amount to
equalize the effect. Indiana declined to do that, so the agreement
was terminated.

As far as I know, however, there's no particular interstate
negotiation involved in the reverse credit arrangements. Instead the
reverse credit is simply a matter of the statutory law of the state
granting the credit to a nonresident. Most states allow credit for
taxes paid to other states only to their own residents, but the states
on the reverse credit list also allow the credit to a nonresident if
the state of the taxpayer's residence would allow credit to a resident
of the granting state.

California law allows a credit to a nonresident if the state of the
taxpayer's residence either does not tax California residents on
income sourced in that state, or allows California residents credit
for the California tax paid on such income. Cal Rev & Tax. Code Sec.
18002. Arizona law contains a similar provision: Ariz. Rev. Stats.
Ann. 43-1096. Since California would allow an AZ resident credit for
the AZ tax paid on California source income, AZ will allow a CA
resident credit for the CA tax paid on AZ source income.

Yes, the state with the higher average rates gets to keep the
difference. On the other hand, AZ gets to keep the tax on its
residents' income from California sources, and CA gets to keep only
the excess, if any, over the AZ tax. Presumably it all comes out in
the wash. A state that felt that, on the whole, it was getting the
short end of the reverse credit relationship would no doubt repeal the
statute that allows credit to nonresidents. In fact, Maryland did
just that a few years ago. Coincidentally, Oregon adopted its
nonresident credit provision at about the same time. So Maryland
dropped off the reverse credit list and Oregon joined it.

Katie in San Diego