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October 13, 2010


The Delaware Real Estate Withholding Tax goes into effect in less than 90 days!  This is something that Delaware Realtors really need to know.
We all know that state and federal taxes must be paid on any gains realized upon the sale of real property.  Delaware residents typically pay those Delaware state taxes with their Delaware State tax return (or as a quarterly estimated tax payment).  But what about individuals who are not Delaware residents?  Starting January 1, 2011, any seller who is not a Delaware resident will have to pay estimated taxes on gains at settlement.  This can create a serious problem for the uninformed seller (and their Realtor), because the seller's net proceeds may be significantly reduced by the withholding of the estimated tax payment.
What Sellers Are Affected?Three types of sellers are affected: 
Individuals who are not Delaware residents.

Pass-through entities that have members who are not Delaware residents or Delaware entities. A pass-through entity is an entity whose income is not taxed at the corporate level. That is, the income passes through to the owners. This would include partnerships, s-corporations and most limited liability companies.

Entities that are not formed in Delaware or are not qualified to do business in Delaware.
So, for example:  If you have a client who is selling her vacation home or investment property in Delaware and your client is not a Delaware resident, then she will be subject to the withholding requirements.   If your seller is a three-person limited liability company (formed in Delaware) but one of the members is not a Delaware resident then the seller will be subject to the withholding requirements with respect to the non-resident member's interest in the gains.  If your seller is a corporation formed in a state other than Delaware and has not qualified to do business in Delaware then the seller will be subject to the withholding requirements.
What Happens if the Seller is Subject to the Withholding Requirements?

The deed cannot be recorded until the estimated tax is paid to the State.  Therefore, the closing attorney will require that the estimated tax be deducted from the seller's proceeds.
Who calculates the estimated tax payment? 

The seller has to calculate the amount of the estimated tax payment based on the seller's gains and applicable tax rate.  If the seller is not able to calculate its actual tax liability in connection with the sale, then the seller can estimate its tax liability by subtracting from the gross sales price (1) the amount of any mortgages or other liens on the property, and (2) all selling costs (real estate commission, transfer taxes, etc.), and then multiplying the net amount by the highest Delaware marginal tax amount (currently 6.95%).  So, for example, if the sales price is $250,000, and the seller has a $150,000 mortgage, and  selling costs are $16,250, then the estimated tax payment might be ($250,000 - $150,000 - $16,250 = $83,750) x 6.95% = $5,820.63.
What happens if the estimated tax amount turns out to be incorrect? 

After settlement the seller should determine, with the help of its tax advisor, the seller's actual tax liability from the sale of the property.  If the amount collected at settlement was not enough, the seller should submit the shortage with its next quarterly estimated tax payment.  If the amount collected at settlement was too much, the seller will have to wait until the seller files its annual income tax return to seek a refund.
The Delaware Department of Finance is still working on regulations to administer the new statute, so there are many questions yet to be answered.  We will keep you informed of any significant progress on this matter.  But in the meantime, you should commit this matter to memory so that you can educate your non-resident sellers early in the process.
Feel free to call Peter Kirsh with any questions.  Thank you!


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