If you’re a commercial real estate investor, you may be aware of the complex rules in a Section 1031 Exchange, also known as a like-kind exchange. Our previously published blog post outlines the guidelines on this federal tax regulation. Many states follow the federal tax code and allow for the deferral of state income tax for like-kind exchanges; however, like-kind exchanges occurring between properties located in different states may have additional state tax implications to consider.
Some states require non-resident withholdings on real estate transactions that occur when an investor lives outside of the state. A handful of states – California, Massachusetts, Montana, and Oregon – have a “claw back” provision, allowing them to tax the gain on the property sale when the deferred gain originated from a property exchange located in their state. For example, if an investor sold a property in Massachusetts and purchased a replacement property in Florida, when the Florida property sells, Massachusetts may “claw back” and impose their state income tax on the gain.
Some of the states with the “claw back” provision have passed bills that require certain tax forms be filed along with a yearly tax return when doing a like-kind exchange. In California, for example, the bill “California AB 92” requires annual information reporting for taxpayers that claim non-recognition of gain or loss for like-kind exchanges with property outside of California. Form 3840 needs to be filed for 1031 exchange recognition, even if no tax return is required in California until the property is ultimately sold.
If you own investment properties in multiple states and have taken advantage of the 1031 Exchange, call us at (401) 921-2000 or submit our contact form to get started. We’re more than happy to assist you in determining state filing requirements.