1031 exchange requirements

1031 Exchange Rules California

Posted on | by Tom Gustafson | Leave a Comment on 1031 Exchange Rules California

Before outlining the specific 1031 exchange rules in California, let’s first introduce the basic concept of a 1031 exchange. In a traditional sale of property, a seller is required to pay capital gains taxes on any gain realized in the sale. One way to avoid paying capital gains taxes is to defer payment by entering into a Section 1031 Exchange. As the name implies, a 1031 Exchange contemplates an “exchange” of like-kind property instead of a traditional sale. If the transaction qualifies, any realized gain is deferred until the replacement property is sold at a later date. One common misconception is that property sold in California must be replaced by property in California, this is not true. The “like-kind” requirement is very general and allows for an Exchangor to acquire property outside of California should they wish to do so. 

The Internal Revenue Service Code sets forth the requirements that must be met in order for a transaction to benefit from 1031 Exchange treatment. In addition to the requirements found in the IRS Code, Qualified Intermediaries must follow additional rules legislated by the State of California for exchanges where the old or relinquished property or the property parked with the Exchange Accommodator Titleholder is located in California.

How does a 1031 exchange work in California? The 1031 exchange rules in California state in general, that anyone who facilitates an exchange for a fee, maintains an office in the state for the purpose of facilitating exchanges, or advertises services as a facilitator in the state, is required to follow the California specific rules.

A Qualified Intermediary operating in California must maintain a bond in the amount of $1 million, deposit an amount of cash or securities or irrevocable letters of credit in an amount not less than $1 million, or deposit all exchange funds in a qualified escrow account or trust account. Anyone who has sustained damages as a result of a facilitator’s violation of the California 1031 exchange rules may make a claim against the bond, account or trust.

In addition, a Qualified Intermediary operating in California must maintain an errors and omissions policy of not less than $250,000 or must deposit cash, securities, or letters of credit in an account designated for the same purpose. Finally, a Qualified Intermediary in California must act as a custodian for all exchange funds and must invest those funds pursuant to a prudent investor standard.

The California Franchise Tax Board also requires a Qualified Intermediary, in most cases, to withhold an amount equal to three and one-third percent of the sales price of any California property as contingency should the exchange not be completed.

Clawback Provision

California has a “clawback” requirement for California property sold in a 1031 exchange and replaced with an out of state replacement property per California FTB Publication 3840. Non-residents are required to file a nonresident income tax return in the year the replacement property is sold in a taxable disposition.

Interested in learning more about when a 1031 exchange makes sense? Click here to download a complimentary eBook on “Ten Reasons Why a 1031 Exchange Makes Sense”.

We strongly recommend conferring with your CPA prior to engaging in a 1031 exchange. It is valuable to have the support and insight of your CPA when making the decision whether or not to proceed with an exchange.

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1031 Exchange: Seller Financing

Posted on | by Tom Gustafson | Leave a Comment on 1031 Exchange: Seller Financing

Given the current tight credit market, taxpayers who want to initiate a 1031 exchange may consider financing or carrying a note for a Buyer to acquire the relinquished property. A 1031 exchange is a strategy to defer the federal and state capital gains and recaptured depreciation tax when selling and replacing property held for productive use in a trade, business or for investment. The tax deferral represents an indefinite, interest free loan that can defer upwards of 40 percent of the sales price. 1031 eligible property includes real property such as timberland, self-storage units, commercial property, single family residential, oil and gas royalty interests as well as personal property including aircraft, precious metals, vintage cars, artwork and collectibles.

Structuring Seller Financing

The Buyer in a typical 1031 exchange acquires the relinquished or old property from the Exchangor with cash, debt or combination of the two. If the Buyer is not able to secure financing, the Exchangor may consider carrying the note. In effect, the note represents an installment loan; however, in a 1031 exchange, the Buyer’s note does not offset debt on the replacement property. The note must be converted into cash by one of the following methods:

  • Assigning the note to the seller of the replacement property as partial payment
  • Selling the note to a third party
  • The Exchangor or related party adding the cash equivalent of the note to the exchange as additional equity

The first two options may not be feasible, leaving the third option dependent upon whether the Exchangor has access to the note’s cash equivalent.

1031 Exchange Carry Back Note Steps

Given the Exchangor has the capital, the carry back note is negotiated between the Exchangor and the Buyer as normal. Prior to the relinquished property closing, the note is made payable by the buyer to the Qualified Intermediary. The relinquished property title is conveyed to the Buyer with a deed of trust and prior to the closing on the replacement property, the Qualified Intermediary sells the note to the Exchangor or a related party. Debt service payments, if any, are paid to the Qualified Intermediary and deposited into an escrow account along with the proceeds of the note sale used to acquire the replacement property. There is no tax when the Exchangor or related party receives principal payments on the note given they will have paid face value to acquire the note. Consequently, all payments other than interest are non-taxable.

One of the benefits of the carry back method described above is, should the replacement property not be acquired, the exchange fails and tax is reported on the installment method in the year the principal and interest payments are received.

Should the note be paid off to the Qualified Intermediary prior to the purchase of the replacement property, the proceeds are used towards the acquisition.

Contact our office at 800.227.1031 or send your questions by clicking on the request for a complimentary consultation below.

1031 Exchange: Seller Financing

Posted on | by Tom Gustafson | Leave a Comment on 1031 Exchange: Seller Financing

Given the current tight credit market, taxpayers who want to initiate a 1031 exchange may consider financing or carrying a note for a Buyer to acquire the relinquished property. A 1031 exchange is a strategy to defer the federal and state capital gains and recaptured depreciation tax when selling and replacing property held for productive use in a trade, business or for investment. The tax deferral represents an indefinite, interest free loan that can defer upwards of 40 percent of the sales price. 1031 eligible property includes real property such as timberland, self-storage units, commercial property, single family residential, oil and gas royalty interests as well as personal property including aircraft, precious metals, vintage cars, artwork and collectibles.

Structuring Seller Financing

The Buyer in a typical 1031 exchange acquires the relinquished or old property from the Exchangor with cash, debt or combination of the two. If the Buyer is not able to secure financing, the Exchangor may consider carrying the note. In effect, the note represents an installment loan; however, in a 1031 exchange, the Buyer’s note does not offset debt on the replacement property. The note must be converted into cash by one of the following methods:

  • Assigning the note to the seller of the replacement property as partial payment
  • Selling the note to a third party
  • The Exchangor or related party adding the cash equivalent of the note to the exchange as additional equity

The first two options may not be feasible, leaving the third option dependent upon whether the Exchangor has access to the note’s cash equivalent.

1031 Exchange Carry Back Note Steps

Given the Exchangor has the capital, the carry back note is negotiated between the Exchangor and the Buyer as normal. Prior to the relinquished property closing, the note is made payable by the buyer to the Qualified Intermediary. The relinquished property title is conveyed to the Buyer with a deed of trust and prior to the closing on the replacement property, the Qualified Intermediary sells the note to the Exchangor or a related party. Debt service payments, if any, are paid to the Qualified Intermediary and deposited into an escrow account along with the proceeds of the note sale used to acquire the replacement property. There is no tax when the Exchangor or related party receives principal payments on the note given they will have paid face value to acquire the note. Consequently, all payments other than interest are non-taxable.

One of the benefits of the carry back method described above is, should the replacement property not be acquired, the exchange fails and tax is reported on the installment method in the year the principal and interest payments are received.

Should the note be paid off to the Qualified Intermediary prior to the purchase of the replacement property, the proceeds are used towards the acquisition.

We Can Help 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

What is a 1031 Exchange

Posted on | by Andy Gustafson | Leave a Comment on What is a 1031 Exchange

Triple Net Lease 1031 Replacement PropertyA 1031 exchange is found in the Internal Revenue Code Section 1.1031. The tax deferral allows federal taxpayers, both U.S. and foreign, to postpone paying federal and state capital gains and recaptured depreciation taxes when selling and replacing property held in a trade, business or for investment. A 1031 exchange is an indefinite, interest free loan that can amount to more than forty percent of the sales price. The tax is ultimately due when the replacement property is sold unless another 1031 exchange is initiated.

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1031 Real Estate Exchange Rules

Posted on | by Andy Gustafson | Leave a Comment on 1031 Real Estate Exchange Rules

1031 real estate exchange rules define how to go about deferring federal and state capital gains and recaptured depreciation taxes when selling and replacing a real property investment. A 1031 exchange, or Internal Revenue Code (IRC) Section 1.1031, allows any entity, both U.S. residents and foreign non-residents, to defer or postpone the payment given certain 1031 real estate exchange rules are strictly followed. The first step is to be aware that the taxes can be deferred indefinitely or until the replacement property is sold. Taxes, both federal and state, along with a twenty-five percent recaptured depreciation tax, can amount to upwards of 40 percent of the property’s sales price. If you could be given up to 40 percent of the real estate sales price interest free to use towards acquiring replacement property, wouldn’t you ask what the 1031 real estate exchange rules and requirements are?

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1031 Exchange Rules: Exchange Requirement

Posted on | by Andy Gustafson | Leave a Comment on 1031 Exchange Rules: Exchange Requirement

Taxpayers frequently enter into a Section 1031 Exchange instead of a traditional sale to avoid the often substantial capitals gains and recaptured depreciation tax obligation due as the result of gains realized upon the sale of real and personal property held for productive use in a trade, business or for investment. If the transaction meets all the requirements of a Section 1031 Exchange, any tax due on the gains realized as a result of the exchange are deferred. Understanding how a Section 1031 Exchange differs from a traditional sale, as well as a full understanding of the rules required for a transaction to qualify for a 1031 Exchange, is essential to taking advantage of the capital gains deferral offered by the exchange.

A Sale vs. 1031 Exchange

In a traditional sale, a seller sells a property and receives the income from the sale at the time of closing. The seller may then decide to purchase another property at the same time or at a later date, but the transactions are separate and distinct. In a Section 1031 Exchange, a seller must both sell and purchase a replacement property as part of one cohesive plan. The transaction will not qualify for Section 1031 treatment unless a replacement property is either identified or acquired by the 45th calendar day following the original property sale. If identified, the purchase of the replacement property is completed within 180 days of the original sale. The Tax Court summed up the concept in Bezdjian v. Commissioner, T.C. Memo 1987-140 by stating “if the Taxpayer’s transfer and receipt of property were interdependent parts of an overall plan the result of which was an exchange of like-kind properties, 1031 applies.”

The use of a Qualified Intermediary is another 1031 exchange requirement that is important to understanding how a Section 1031 Exchange works. Because the transaction is an exchange, not an outright sale, the proceeds from the original sale should never actually be available to the seller as is the case in a traditional sale. Instead, the proceeds are held by a Qualified Intermediary to be used for the purchase of the replacement property. Likewise, the deed for the replacement property must be held by the Qualified Intermediary until the exchange has been completed. Using a Qualified Intermediary is found in the safe harbor rules and “will result in a determination that the taxpayer is not in actual or constructive receipt of money or other property for purposes of section 1031,” according to Regulation 1.1031(k)-1(g)(6).

Finally, it is important to understand that Section 1031 is mandatory. As the court held in U.S. v. Vardine, 305 F.2d 60 (1962), “1031 and its predecessor are mandatory, not optional; a taxpayer cannot elect not to use them.” Although in most cases it is in the taxpayer’s best interest to invoke the benefits of a 1031 Exchange, there may be times when a taxpayer may not wish to do so. As the court pointed out, however, Section 1031 is mandatory.

Complimentary Downloads

To learn ten reasons why a 1031 exchange makes sense, download the complimentary eBook by clicking here. To view a library of complimentary 1031 exchange eBooks for individuals, trusts, corporations, franchise owners, ranchers and farmers, timberland owners, lawyers, CPAs, Realtors and escrow and title officers visit the Atlas 1031 Exchange Resource page.