Effective January 1, 2014, for California 1031 exchanges initiated for property within the state and replaced with property acquired outside the state, the taxpayer must file the status of the replacement property with the California Franchise Tax Board (FTB) each year until the property gain or loss is recognized using California FTB form 3840. For the FTB form and instructions go to the following link. If the taxpayer elects not to file, the deferred state capital gain is due even if the property was not sold. Assembly Bill 92 and Revenue and Taxation Sections 18032 and 24953 became law on June 27, 2013. This development reflects the California deficit challenges and lawmakers seeking opportunities to clawback state capital gain tax revenues.
Tax on Cash Boot
The Franchise Tax Board already assesses a 3 1/3 percent withholding tax on individuals exchanging California real property and either (i) the exchange does not take place or (ii) the statutory time periods set forth in Internal Revenue Code 1031(a)3 (the 45-day identification period and 180-day exchange period) expire without the receipt of replacement property. California Instructions Form 593-C provides the Qualified Intermediary, or QI, shall withhold 3 1/3 percent of any cash boot payable to taxpayer if replacement property is received during statutory time period but some remaining cash boot is paid by QI to taxpayer.
These provisions apply to resident and non-resident individuals, including grantor trust and certain limited liability companies that are treated as disregarded entities and are owned by one of more individuals. The taxpayer will be credited with any California withholding tax against the taxpayer’s California income tax liability. If these California withholding provisions apply, the QI will file California Form 597 within twenty (20) days following the month of the event requiring withholding as provided in the Instructions to Form 597, including sending Copy A of Form 597 to the Franchise Tax Board (with payment of the withholding tax) and sending Copy B and C to the taxpayer.
1031 Exchange Rules
Property must meet certain criteria to qualify for the exchange. Both the real and tangible and intangible personal property being disposed and replaced must satisfy 1031 exchange rules and requirements to qualify. The properties must have been held for investment purposes or productive use in a business or trade. Eligible Property that qualifies includes land, buildings, leasehold interests, machinery, aircraft, vehicles, collectibles, precious metals, franchise rights and thoroughbred race and show horses. However, primary residence, partnership interests, inventory, indebtedness or securities such as stocks or bonds do not qualify for 1031 tax deferral treatment.
For property to be considered for an exchange the replacement property must be a like-kind or like-class property. Property for property, machinery for machinery or building for building would qualify. An exchange of a piece of machinery for a building would not be considered. There are additional rules on exchanges of mixed use, multiple asset properties as well as transfers between related parties.
Property Identification
When the taxpayer disposes the relinquished or old property, the replacement must be known by the 45th calendar day post transfer. This identification period makes sure that both the property the taxpayer is transferring and the property the taxpayer is receiving are formally identified, preferably to the QI. The property must be received by the taxpayer within 180 calendar days of the transfer of the original property. If in a reverse exchange, the replacement property is acquired first and the property to be sold must be formally identified to the QI by the 45th calendar day post-closing.
QI Role
QIs are an important part of any like kind exchange. This gives all parties in the exchange an independent third party to help accommodate the exchange. The role of the QI includes preparing documentation supporting the taxpayer’s intent in accordance with Internal Revenue Code regulations and holding the exchange funds in a safe, liquid escrow account, preventing the taxpayer with access to the funds.
Learn ten reasons why a 1031 exchange makes sense by clicking here or visit downloads to see fourteen different 1031 exchange eBooks and eGuides for Taxpayers, Realtors, CPAs, Attorneys, Escrow Officers and owners of timberland, franchises and businesses, precious metals, aircraft, ranches and farms.
