Three questions for my first 1031!

1031 Exchanges
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Three questions for my first 1031!

Danny Nikolai
Member since 2019 · 1 post · 1 vote

Hey BP community, 

I'm hoping to 1031 a property from California into a state with no income tax, and am planning on relocating most of my estate into this new state over time. I have three questions about completing this 1031...

1. 1031's must be exchanges of "like" properties. Can I sell my existing property and use a portion of the proceeds to purchase undeveloped land and the other portion to develop that land? Or is the money required to develop considered part of a boot that is subject to capital gains tax?

2. If I sell my property in California and then find two properties elsewhere whose values are greater than or equal to the sales price of my first property, can I do a 1-for-2 type of exchange with a 1031?

3. If I have a cash boot left over after an exchange into a different state, is that boot subject to the income tax rate in the new state or the old state?


Thanks in advance! I'm looking forward to learning more on this journey. 

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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
5y

Hi @Danny Nikolai, 

California has what we refer to as the California Claw Back.  California takes the position that if you 1031 Exchange out of property in California into property in another state it is tax-deferred but you will still owe California taxes if you ever sell, cash out and pay the taxes.  California put in reporting requirements so that you must report the status of the new replacement property to California each year even if you completely move out of the state.  

Like-kind property means that you are selling real estate and must 1031 Exchange into real estate as long as the properties sold and ultimately acquired are held for rental, investment or business use.  You can acquire vacant undeveloped land and then use the remaining portion of your proceeds to improve the land.  It is referred to as an Improvement 1031 Exchange or Build-To-Suit 1031 Exchange.  These are more complicated because the Qualified Intermediary must acquire and hold or "park" legal title to the replacement property during the 180 calendar day exchange period.  

You can sell one relinquished property and acquire two replacement properties.  The 1031 Exchange is a great strategy when you want to diversify your investment from one into two properties.  

The cash boot would only be subject to taxes in the state where the relinquished property was sold.  

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Danny Nikolai, 

    California has what we refer to as the California Claw Back.  California takes the position that if you 1031 Exchange out of property in California into property in another state it is tax-deferred but you will still owe California taxes if you ever sell, cash out and pay the taxes.  California put in reporting requirements so that you must report the status of the new replacement property to California each year even if you completely move out of the state.  

    Like-kind property means that you are selling real estate and must 1031 Exchange into real estate as long as the properties sold and ultimately acquired are held for rental, investment or business use.  You can acquire vacant undeveloped land and then use the remaining portion of your proceeds to improve the land.  It is referred to as an Improvement 1031 Exchange or Build-To-Suit 1031 Exchange.  These are more complicated because the Qualified Intermediary must acquire and hold or "park" legal title to the replacement property during the 180 calendar day exchange period.  

    You can sell one relinquished property and acquire two replacement properties.  The 1031 Exchange is a great strategy when you want to diversify your investment from one into two properties.  

    The cash boot would only be subject to taxes in the state where the relinquished property was sold.  

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Bonnie LowPro Member
    Lender · Asheville, NC · Member since 2016 · 1k+ posts · 1k+ votes
    5y

    @Bill Exeter - great info on the CA Clawback laws. We own properties in CA that we would like to 1031 eventually out of state so we'll definitely look into tax strategies further before taking any action.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Danny Nikolai, You're probably anticipating a move into that tax free state.  Owning property in a tax free state while you still reside and pay taxes in another generally leaves you still paying tax on profits from your activities in the tax free state.  CA and other states may give you credit for taxes paid in other states.  But if there are none (as in a tax free state) they will get you for it all.

    However moving property out of the state and moving yourself out of the state will work from an income tax perspective.  One of the big drivers of the NY exodus down I-95 to FL or the move out I-15 to NV.  Stay tuned regarding the CA clawback.  More than a few people (some of them heavily lawyered up) are considering that the CA clawback cannot be enforced if you are no longer a CA resident.  I'ts going to play out in the courts fairly soon and may have some huge ramifications on things.


    Land is a perfectly fine replacement.  However, you cannot exchange into improvements on land you already own.  So a reverse construction or improvement exchange is going to be needed.  These can get expensive.  But we've done several this year as clients are liking the "glamping" or RV park type of real estate investment.  Still some severe limitations on time.  So these lend themselves better to improvements or infrastructure rather than ground up construction.

    As long as you purchase at least as much real estate as your net sale and use all of the proceeds you'll defer all tax.  The number of properties does not matter (other than the identification limits). What your describing is a fairly common scenario called a "diversification" exchange.  One to multiple or multiples to one.  It can go either way.

    Left over boot is going to be a federal matter primarily.  But both states will be So it will be paid within the structures of the state your file in as well as your federal return, and your state return, and the state where the property was located (if different and is there is a state tax at that level).  State tax law can be tricky.  There are many states that want their share whether or not you live there if the property is located in your state.  And many states don't care if it's in another state they will want their share just because you live in their state.  You may very well end up having to appease two states and the fed tax wise.

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