California’s 1031 Exchanges – What to Keep in Mind

Under California Tax Code Section 1031, if a taxpayer exchanges real property for like-kind real estate, gain on the exchange is deferred until the replacement property is sold. According to the Internal Revenue Service, properties are of like-kind if they are of the same nature or character, even if they differ in grade or quality. The real estate must be either a business or investment property – not a personal residence or personal, tangible, property. However, improved property can be exchanged for unimproved property.

Further, replacement property must be identified within 45 days of the transfer of relinquished property. The closing of the replacement must occur by the earlier of: (1) 180 days after the date of the transfer of the relinquished property; or (2) the due date (including extensions) of the transferor’s tax return for the tax year in which the transfer of the relinquished property occurs.

Generally, under Section 1031, a person is not required to recognize a gain or loss. However, if a person does not receive “like-kind” property or money as part of the exchange, then he or she must recognize the gain to the extent of the property and money received.

Additionally, a person purchasing are placement property who assumes a liability, such as a mortgage payoff at closing, can offset that taxable income. However, the mortgage on that replacement property must be an amount equal to or greater than the debt on the relinquished property.

When property is purchased out-of-state under a 1031 exchange, California aggressively tracks when that replacement property is sold and treats the gains as California source income to the extent of the original deferred gain. This is monitored through a strict reporting policy. This tax is separate and in addition to any taxes sought by the state where the property is located.

Thus, while 1031 exchanges can be beneficial, understanding the rules is important to avoid costly tax errors. Prior to conducting a 1031 exchange, it is important to speak with a professional with knowledge on this area of law. The attorneys at Tyler Law LLP are here to advise and assist in any questions or concerns you may have regarding 1031 exchanges.

Contact our office at 951-600-2733 if you are seeking counsel.

BY: ROBERT H. TYLER, ATTORNEY AT LAW NATHAN KLEIN, ATTORNEY AT LAW