1031 Exchanges: Exchanging Out of California? Do Keep In Touch

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As we have noted previously, many property owners are aware that one can sell investment property and reinvest the sales proceeds in like-kind investment property without having to pay tax on the sale. Such transactions are known as “tax-deferred exchanges” or “1031 exchanges” (1031 being the Internal Revenue Code section that authorizes the transactions). Certain requirements must be satisfied, such as (in the case of a nonsimultaneous exchange) identifying and acquiring the like-kind replacement property within specified time periods after the sale of the relinquished property. Generally, as long as the proceeds from the sale of the relinquished property are invested in like-kind replacement property, the tax on the sale is essentially deferred and is payable upon a subsequent taxable sale of the replacement property. (See 1031 Exchanges of Investment Property—Recent Cases.)

If you sell relinquished property in California and acquire replacement property outside of California, the State of California wants you to keep in touch. Effective January 1, 2014, all taxpayers who defer gain or loss under Section 1031 by selling relinquished property in California and acquiring replacement property outside of California will have to file an information return with the California Franchise Tax Board (FTB) for the year of the exchange and for each subsequent year in which the gain or loss from that exchange has not been recognized, in the form and manner prescribed by the FTB.

In a news release, the FTB states that the annual filing will help taxpayers and the FTB keep track of California source gain deferred under 1031 exchanges. According to the news release, after exchanging relinquished property in California for replacement property outside of California, many taxpayers later sell the replacement property and the previously deferred California source gain is not reported to the State of California. The FTB further states that, as to those taxpayers who exchange relinquished property in California for replacement property outside of California and fail to file the California information return, the FTB may issue a Notice of Proposed Assessment to adjust their income for the previously deferred California source gain, plus penalties and interest.

Topics:  Franchise Tax Board, Franchise Taxes, IRC, Section 1031, Tax-Deferred Exchanges

Published In: Commercial Real Estate Updates, Residential Real Estate Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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