Delaware’s New Mandatory Withholding of Estimated Income Tax for Non-Residents on Real Estate Transactions on Form 5403 (starts 1/1/2019)

“To all my Delaware settlement attorney friends, I wanted to share my notes from the past year of meetings, conference calls, and the special 1-hour CLE seminar in October 2018 on the changes taking place on 1/1/2019 for the Form 5403. If you have any comments or suggestions, I’d love to hear them as I’m trying to make this as simple as possible without us all becoming CPAs on the side.”

Brian Funk’s Unofficial Guide to the 2019 Delaware Form 5403 Non-Resident Withholding Changes (11-14-2018)

2019’s Delaware Form 5403

Brian Funk’s Unofficial Guide to the Universe for Delaware Settlement Attorneys on the New Delaware Form 5403 for Non-Resident Withholding on Sale of Real Estate

(updated on 11/14/2018 8:10am)

  • What is the purpose of withholding income tax on the sale of real property on non-residents?
    • Income tax is imposed on gain from the sale of real property (unless it’s exempt). In English, the gain is calculated by taking the amount realized and subtracting it from the adjusted basis. It’s obviously harder for Delaware to collect from folks who live out-of-state than those in-state so we’re now being required to collect an estimated payment at the time of settlement.
    • It’s important to remember that this is a Delaware law and it has nothing to do with the separate, federal Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) withholdings for foreign persons.
  • What is the currently start date for the new Form 5403?
    • The current start date is for transactions occurring on or after January 1, 2019.
  • Who must fill out the Form 5403?
    • Everyone, but the income withholding part is only mandatory for non-residents who do not qualify for an exception.
  • Who is a “non-resident” for the purposes of Form 5403?
    • Business entities:
      • A business entity is a “pass-through entity” if it is either: (1) taxed as partnership by the IRS or (2) classified as an S-Corporation by the IRS.
      • Normal Entities (i.e. C-Corp):
        • Any business entity that is not organized, qualified, or registered to do business at the Delaware Secretary of State.
          • Example 1: If the entity is domesticated in California and registered as a “foreign” corporation in Delaware, then it is considered a resident for the purposes of this form!
          • Example 2: If the entity is domesticated in California but has filed nothing in at the Delaware Secretary of State, then it is considered a non-resident.
        • Pass-Through Entities:
          • 30 Del. C. §1606(a)(2) says if the business is a “pass-through entity”, it considered a non-resident entity if 1 or more members are non-resident individuals or corporations.
          • If it is a pass-through entity, then you do an analysis on all of the individual members/partners. If just one of them is a non-resident, then a withholding must be done; however, the Director of Division of Revenue confirmed that only one 5403 is necessary for the entity. (You can use an extra piece of paper to distinguish withholdings for resident and non-resident members.)
        • Individuals:
          • 30 Del. C. §1126(a)(2) says that you are considered a non-resident individual of Delaware if you are a not a resident for the “entire tax year.
          • So if you are a person moving out-of-state after the settlement, you would be considered a non-resident for the purposes of the 5403 form (because you clearly wouldn’t be a resident for the entire tax year).
          • It’s up to the Seller to make this declaration honestly.
  • What is “adjusted basis” for the purposes of Form 5403?
    • The topic of determining one’s “basis” cannot even be properly covered in single-semester law school course on taxation; however, IRS Publication 551 is a good place to start.
    • The starting point for having a correct adjusted basis is the whole point of having a good Certified Public Accountant (CPA) provide the numbers.
    • However, the quick and easy answer for what a seller’s adjusted basis may be:
      • If the property is was a primary or secondary residence for the taxpayer (i.e. not a rental property and not a commercial property), the answer essentially is: the original purchase price plus costs to acquire it plus the cost of any improvements that the taxpayer has made to the property.
      • If the property is was an investment or commercial property, the answer essentially is: the original purchase price plus costs to acquire it plus the cost of any improvements minus depreciation.
      • If the property was received as a gift (and not one received after a death inheritance) by the seller, then the Giftee’s (i.e. the current seller) is the same as the Giftor’s basis.
      • If the property was received as an inheritance resulting from a death (through probate or a trust), then the seller’s basis is what the fair-market value of the real property was on the date of death (which is often referred to as the “stepped-up basis” and one of the rare tax advantages in life).
  • What are the other “exemption” boxes?
    • “Sale of Exchange Exempt from Capital Gain Recognition” (2nd Box under Number 5)
      • The most common reason to check this box would be if a primary residence is being sold and the amount of gain is under $250,000 if single or $500,000 for a married couple.
      • Obviously, there are other reasons why the sale of real property may be exempt (i.e. insolvency); however, those reasons are for a CPA to determine and decide.
    • “Gain realized excluded from income for tax year of sale or exchange” (3rd Box under Number 5)
      • A good example here is a 1031-exchange is being done by the seller.
      • You would need a CPA to make this determination properly.
    • “Sale Exempt due to Foreclosure” (4th Box under Number 5)
      • Sheriff Sales
      • Deeds-in-Lieu of Foreclosure
      • Sale from the Party Acquiring the Property at a Sheriff Sale or Deed-in-Lieu
    • If the Seller is giving “Seller Financing” to the Buyer (i.e. a purchase-money mortgage), then the Seller is entitled to check box #7 and not withhold.

Note: The material provided herein is for educational purposes only and does not constitute legal or tax advice by the drafter. No warranties express or implied.