When you sell real estate in Ocean City and are not a resident of the state of Maryland you need to be aware of the non-resident withholding tax. In 2003 the State of MD enacted code that provided for income tax withholding on the sale of real estate in Maryland by non-resident individuals or entities.
Many non-residents of Maryland were selling real estate in Maryland and never reporting the gain as they are required to do via a Maryland tax return. As a result the state of Maryland was losing out on substantial tax revenue. This was obviously not acceptable to the State of Maryland and the non-resident withholding tax is the result.
Settlement companies in the State of Maryland are charged with the duty of collecting the tax on the net gain at the time of settlement. The tax currently stands at 7.5% for individuals and 8.25% for entities (verify current tax rates at the time of reading). The way this works is the settlement company is required to collect the tax based off of the net proceeds from the settlement statement. As an example lets assume you sold a property for $500,000 and had $40,000 in closing costs and a payoff to your mortgage holder of $250,000. This would lead to net proceeds on the settlement statement of $210,000. The settlement company would then be obligated to collect $15,750 in non-resident withholding tax ($210,000 gain @ 7.5%).
Now the reality of the situation is that you likely paid more for the property than the $250,000 that you owe on the mortgage. Under the scenario above lets assume you paid $300,000 for the property. In addition you had closing costs when you purchased the property that were likely in the neighborhood of $15,000. This adds up to an adjusted costs basis of $355,000 (purchase price plus closing costs for the initial purchase and this sale). Subtracting this from the $500,000 sales price gives us a real gain of $145,000 and a non-resident withholding tax of $10,875.
An even worse scenario is if you paid cash for the property. Let's assume you bought a $300,000 property and paid cash. You then sell this property for $400,000 with $30,000 in closing costs associated with the sale. The settlement statement will have net proceeds to you of $370,000 and $27,750 of non-resident withholding tax will be collected. In reality you have a gain of approximately $55,000 factoring in the purchase price and closing costs for the initial purchase and this sale. The non-resident tax owed on this is $4125, which is far less than $27,750.
If a non-resident Seller does nothing prior to settlement the title company will be obligated to collect the withholding tax based off of the net proceeds from the settlement statement as outlined above. This can be avoided by filing for an exemption request with the Comptroller of Maryland prior to the property settlement.
The process for obtaining the exemption can not be started until you have an accepted contract on your Ocean City real estate and are proceeding towards settlement. Once you have a signed offer in place you can then fill out the necessary exemption forms. These forms will take into account what you paid for the property, closing costs for both your initial purchase and this sale and any improvements that you made to the home or condo. You will then package the forms together with the contract of sale and a preliminary settlement statement that I will have prepared for you and send it to the Comptrollers office for review. The Comptroller's office requests 21 days to get the process completed, which is usually ample time under most contract timeframes.
In most situations you can expect to get a partial exemption, meaning you will only be paying the withholding tax on the true net gain of the property. In order to qualify for a full exemption and pay no tax at the time of sale you must meet one of the following conditions:
- Seller is a resident of the State of Maryland
- Property is a primary residence
- Property transfer is a result of foreclosure
- Property is transferring at zero value
- Property transfer is part of a 1031 tax deferred exchange
Once the exemption is granted the Comptroller will provide the title company that is conducting the property closing with a certificate authorizing the full or partial exemption.
In the event that your Realtor did not advise you of the MD Non-Resident Withholding Tax prior to settlement there is a process you can go through to retrieve any overpaid monies. There are forms that you will need to complete and file with the Comptrollers office 60 days after the property settlement date. You will essentially be going through the same process that was outlined above after the fact and the overpaid taxes will be refunded to you.
As an experienced Ocean City Realtor I deal with non-resident withholding taxes on a regular basis and would be glad to assist you with the process. I initiate this process for all of my listing clients as soon as they have a ratified contract in place for the sale of their property, then follow it through to completion. This allows ample time to get the exemption in place prior to closing.
If you would like to discuss this in greater detail or have any other questions feel free to contact me anytime at 443-614-9179.
Quick question for you: as a result of the withholding, does a nonresident seller need to have more cash at closing to cover the payment than a resident seller, or is the amount taken out of the proceeds from settlement?
If there are adequate proceeds from the sale the withholding tax will be deducted from them. In the event there is not adequate funds the Seller would need to bring the necessary funds to closing. Hope that helps. Let me know if you have any other questions.
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