The Personal Income Tax Law provides, in modified conformity to federal income tax laws, for the manner in which taxable gains are to be recognized upon the disposition of property, including real property that is the principal residence of the taxpayer. Existing law allows an individual to exclude from his or her gross income up to $250,000 or $500,000, as specified, of gain realized on the sale or exchange of his or her residence if the taxpayer owned and occupied the residence as a principal residence for an aggregate period of at least 2 of the 5 years prior to the sale or exchange.

This bill would revise the exclusion to provide that if the buyer of a qualified principal residence, as defined, is a qualified first-time homeowner subject to the income tax imposed by this state homeowner, as defined, the amount of the exclusion is increased to $300,000 or $600,000, as specified. The bill would limit the increased exclusion amount to transactions in which, on or prior to the closing date of the sale or exchange of the qualified principal residence, the seller obtains a certification from the buyer in writing, signed under penalty of perjury, that the buyer is a qualified first-time homeowner and including specified information concerning the sale of the qualified principal residence. By expanding the scope of the crime of perjury, this bill would impose a state-mandated local program.

This bill would take effect immediately as a tax levy.

Existing law, the Cal-First Home Buyers Act, requires the California Housing Finance Agency to administer its provisions, as specified.

This bill would make a nonsubstantive change to this provision.

SENATE COMMITTEE ON APPROPRIATIONS

Senator Ricardo Lara, Chair

2017 - 2018 Regular Session

SB 1116 (Moorlach) - Personal income taxes: exclusion: capital gains: sale of residence

This bill meets the criteria for referral to the Suspense File.

Bill Summary:

SB 1116 would increase the Home Sale Gain Exclusion for sellers who sell to a first-time homeowner.

Fiscal Impact:

The Franchise Tax Board (FTB) estimates that the bill would result in General Fund revenue losses of $130 million in 2018-19, $75 million in 2019-20, and $75 million in 2020-21. FTB’s costs to implement the bill have yet to be determined.

Background:

Tax expenditure programs (TEPs) are special tax provisions that reduce the amount of revenues the “basic” tax system would otherwise generate in order to provide (1) benefits to certain groups of taxpayers, and/or (2) incentives to encourage certain types of behavior and activities, such as charitable giving. Specifically, current law provides for, among other things, various income and corporation tax credits and deductions, as well as exemptions from the sales and use tax. The Department of Finance is required to publish a list of TEPs (currently totaling several hundred), which currently $61 billion annually.

With respect to calculating tax liability, gross income means all income regardless of source, unless specifically exempted. Federal and state laws grant a Home Sale Gain Exclusion, which allow taxpayers to exclude the capital gain from the sale of their home. To qualify for the exclusion, taxpayers must have lived in their home for at least two of the last five years. The gain is limited to the following amounts: (1) $250,000 for taxpayers who are single or married filing separately, and (2) $500,000 for taxpayers who are married filing jointly or surviving spouses who sell their home within two years of their spouse’s death. Taxpayers selling vacation homes, rental property, or a home that they have only lived in for one year cannot claim the exclusion.

Proposed Law:

This bill would, beginning taxable year 2018, increase the seller’s maximum excludable gain on the sale of a principal residence from $250,000 to $300,000 for individuals and from $500,000 to $600,000 for joint return filers and surviving spouses, for the sale of a qualified principal residence, as defined, to a certified qualified first-time homeowner, as specified.

Related Legislation: SB 401 (Wolk, Chapter 14, Statutes of 2010) changed the specified date from January 1, 2005, to January 1, 2009, for taxable years beginning on or after January 1, 2010, which among other things, conformed to federal law that allows surviving spouse to exclude from gross income up to $500,000 of the gain from sale of principal residence if the sale occurs within 2 years of the death of the spouse.

Staff Comments:

FTB’s revenue estimate is based on a proration of a similar estimate done by the Joint Committee on Taxation (JCT). In January 2017, the JCT estimated the federal revenue impact of the exclusion of capital gains on sales of principal residences to be $33 billion in federal fiscal year 2019. To determine California's share of the federal loss, California Association of Realtors (CAR) and National Association of Realtors data was used to calculate that 19 percent of dollar volumes for homes sales are attributable to California. Next FTB analyzed federal and state capital gains tax rates and estimated a federal/state tax adjustment of 60 percent ($3.8 billion). Using data from CAR, FTB determined that 35 percent of home sales are to first-time homeowners. Of the sales to first-time homeowners, FTB estimated that there would be a five percent increase in the amount excluded, resulting in an estimated revenue loss of $65 million in taxable year 2018.

Any local government costs resulting from the mandate in this measure are not state-reimbursable because the mandate only involves the definition of a crime or the penalty for conviction of a crime.

-- END --

SENATE COMMITTEE ON GOVERNANCE AND FINANCE

Senator Mike McGuire, Chair

2017 - 2018 Regular

Personal income taxes: exclusion: capital gains: sale of residence

Increase the Home Sale Gain Exclusion for sellers who sell to a first-time homeowner.

Background

Tax expenditures. California law allows various income tax credits, deductions, exemptions, and exclusions. The Legislature enacts such tax incentives to either compensate taxpayers for incurring certain expenses, such as child adoption, or to influence certain behavior, such as charitable giving. The Legislature uses tax incentives to encourage taxpayers to do something that but for the tax credit, they would otherwise not do. The Department of Finance is required to annually publish a list of tax expenditures, currently totaling around $61.3 billion per year.

Home Sale Gain Exclusion. For tax purposes, gross income means all income regardless of source, unless specifically exempted. Federal and state laws grant a Home Sale Gain Exclusion, which allow taxpayers to exclude the capital gain from the sale of their home. To qualify for the exclusion, taxpayers must have lived in their home for at least two of the last five years. The gain is limited to the following amounts:

• $250,000 for taxpayers who are single or married filing separately; and
• $500,000 for taxpayers who are married filing jointly or surviving spouses who sell their home within two years of their spouse’s death.

If taxpayers are selling their vacation home, rental property, or a home that they have only lived in for one year, they cannot claim the exclusion.

California real estate market. California is in the midst of a housing crisis. Home prices in California are much higher than they are in other states. According to the Legislative Analysist’s Office’s (LAO) California’s High Housing Costs report, as of early 2015 the average home in California cost $437,000 which is more than double the average home price in the U.S ($179,000). With the high cost of homes, many Californians must rent. However, the state’s average monthly rent in 2013 was $1,240, nearly 50 percent more than the national average of $840 per month. High rental costs inhibit taxpayers’ ability to save, which can cause renters to forestall — or even forego — homeownership.

Additionally, the state has a severe housing shortage. The LAO reports that the state’s major metro areas added about 120,000 new housing units each year from 1980 to 2010. However, to have kept the state’s housing costs steady, California needed to have built 190,000 to 230,000 units per year. Not to mention that many homes are being bought in cash. According to ATTOM Data Solutions — a multi-sourced national property data warehouse — in 2006, 10 percent of all homes in California were purchased in cash.^[1] In 2017, 23.7 percent of all homes in California were purchased in cash.^[2] Many first-time homeowners do not have enough money to pay for a house in cash. They have to obtain a loan which takes time and delays the close of sale. Sellers would rather sell to an all cash buyer because the deal can close much quicker. Thus, individuals using bank loans rather than cash to buy a home are at a disadvantage to those who can pay in all cash.

High home prices, high rents, limited housing, and increases in all-cash deals make it difficult — if not impossible — for Californians who want to buy their first home. The author would like to provide an incentive for taxpayers to sell their home to a first-time homeowner by increasing the Home Sale Gain Exclusion.

Proposed Law

Senate Bill 1116 increases the Home Sale Gain Exclusion for taxpayers who sell their home to a first-time homeowner. The bill increases the exclusion to the following amounts:

• $300,000 for taxpayers who are single or married filing jointly; and
• $600,000 for taxpayers who are married filing separately, a head of household, or a surviving spouse.

The increased exclusion would be available for taxable years beginning on or after January 1^st, 2018.

State Revenue Impact

According to the Franchise Tax Board, SB 1116 results in revenue losses of $130 million in 2018-19, $75 million in 2019-20, and $75 million in 2020-21.

Comments

1. Purpose of the bill. According to the author, “SB 1116 provides a small incentive to encourage a sale to our younger residents that are just starting out in life, thus making homeownership attainable for working Californians.”

2. Revenue loss. Existing tax law provides various credits, deductions, exclusions, and exemptions for certain taxpayers. Since these tax expenditures are enacted to accomplish some governmental purpose and have a cost — in the form of foregone revenues — state law refers to them as "tax expenditures." This bill would increase an existing tax expenditure, costing the General Fund $130 million in foregone revenue in the first year. As a result, the state will have to reduce spending or increase taxes to match the foregone revenue. The Committee may wish to consider whether SB 1116 is a cost-effective way to help California families purchase their first home.

3. Conformity issues. In general, state conformity with federal law promotes greater simplicity and eases the burden of administering complex tax law. However, SB 1116 would create a difference between federal and state tax treatment of a taxpayer selling his or her principle place of residence to a first-time homeowner. While this specific type of expense would receive an increased deduction for state purposes, it would not receive an increased deduction for federal purposes. The Committee may wish to consider whether the burden on taxpayers created by a lack of conformity is worth the tax benefit provided.

4. Related parties. SB 1116 allows a taxpayer to sell his or her home to a first-time homeowner and receive an increased exclusion. However, SB 1116 does not exempt related party transactions. In other words, a mother could sell her home to her son — a first-time homeowner — and still receive the increased exclusion. The Committee may wish to amend SB 1116 to exclude sales between related parties from the increased exclusion.

5. Windfall. Tax expenditures, such as an increased exclusion amount, accomplish two things. First, they reward behavior that would have occurred without the subsidy, providing a windfall benefit for taxpayers who would’ve sold their home to a first-time homeowner regardless. In this case, the state receives no marginal benefit and loses revenue. Second, the tax expenditure may lead to more sales to first-time homeowners that wouldn’t have occurred without the extra incentive. In this case, first-time homeowners benefit and the government accomplished its goal. Successful tax expenditures produce more benefits than costs. However, no tax credit has conclusively demonstrated that its aggregate gains exceed its fiscal losses.

6. Verification. To claim SB 1116’s tax benefit, a seller has to sell their home to a first-time homeowner. However, the seller must have some evidence the buyer was a first-time homeowner in case an audit determines otherwise because the seller would then be subject to accuracy related penalties. Neither a definition for first-time homeowner, nor a certificate that verifies the buyer is indeed a first-time homeowner exist in SB 1116. The Committee may want to amend the bill to provide FTB with a means to verify that the buyer is a first-time homeowner and a definition for the term.

Support and Opposition

(5/3/18)

Support: Orange County Realtors (sponsor).

Opposition: Unknown.

-- END --

1. Levin, Matt. “Data Dig: Are Foreign Investors Driving up Real Estate in Your California Neighborhood?” CALmatters, 20 Mar. 2018, calmatters.org/articles/data-dig-are-foreign-investors-driving-up-real-estate-in-your-california-neighborhood/. ↑

2. Ibid. ↑