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Exchanging Out of State – Special Considerations for Investors

Exchange Update

Investors often sell property in one state and purchase real estate in another state – whether to achieve greater portfolio diversification, increase the power of their dollar, or move investments to their state of residence, there can be benefits to moving an investment from one state to another. A taxpayer may take this approach when completing a tax deferred 1031 exchange. This is permissible because real estate located in one U.S. state is considered “like-kind” to real estate located in any other state for exchange purposes.

In most cases, exchanging out of state allows a taxpayer to defer both state and federal income taxes (assuming the state has income taxes). However, note that taxpayers doing an exchange should always consult with their tax advisor regarding certain nuances that may apply from state to state to recognition of tax-deferred exchanges.

Certain states have special “claw back” laws that allow the state to track a taxpayer’s subsequent purchases and sales of property using proceeds from a property sold in that state. This way, when capital gains become due, the state can collect tax on the gains allocable to that state, even years later. This can at times result in double taxation as to some portions of a taxpayer’s capital gains. Currently, state with these claw back laws include California, Massachusetts, Montana, and Oregon.

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Using the 1031 Exchange as a Tool for Portfolio Diversification

Exchange Update

Using the 1031 Exchange as a Tool for Portfolio Diversification

As market forces such as inflation, increased interest rates and shifting demographics have created greater uncertainty in real estate investing, investors may find diversification of their real estate holdings to be a greater necessity than ever before.

There are several options available when choosing replacement property or properties to acquire with proceeds through a Section 1031 exchange, allowing taxpayers selling investment property to use the tax-deferral mechanism as a tool for diversifying their portfolio.

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Extensions for Federally Declared Disasters

Exchange Update

Extensions for Federally Declared Disasters

Extensions of 45 and 180-day Deadlines Due to Natural Disasters

There have been a number of recent natural disasters affecting the United States, and our hearts go out to all those affected. For affected taxpayers impacted by a disaster, there is relief available in the form of extensions for completing the exchange. See below for the criteria that qualifies taxpayers for one of the below-referenced extensions.

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When an Exchange Straddles Two Tax Years

Exchange Update

When an Exchange Straddles Two Tax Years

As we begin another new year, many Exchangors will find themselves with an exchange that straddles two tax years. That situation usually leads to one of two questions:

  1. My exchange was a success, but what year do I use to report the transaction?
  2. My exchange failed. I got my money back, but when do I report the gain?

The first question is easy. The exchange is reported on IRS form 8824, for the tax year in which the relinquished property was transferred. So, for an exchange that began in 2021 and concludes in 2022, the transaction is reported on the taxpayer’s 2021 tax return. If there are unused exchange funds, or “boot”, the receipt of such funds can be reported on the 2022 tax return, using IRS form 6252.

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Safely Refinance A 1031 Property

Exchange Update

Refinancing Before or After an Exchange

Seasoned 1031 exchangors know that if they receive cash in an exchange, rather than investing it in the replacement property, the transaction will be partially taxable. It’s not surprising, therefore, that many real estate investors plan to refinance the relinquished property immediately before an exchange, or the replacement property immediately after an exchange, in order to get cash out of the property without being taxed.

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Holding Period Requirements in a 1031 Exchange – Not Just a Matter of Time, Intent is Key

Exchange Update

Property must be “held” for investment or business use (a “qualified purpose”) in a 1031 tax-deferred exchange. This requirement applies to property being sold to start an exchange, as well as property acquired as replacement in an exchange. The length of a holding period is often cited by exchanging taxpayers to satisfy the qualified use requirement, but time is just one factor that the IRS and courts will consider in determining the taxpayer’s intent. Though the Internal Revenue Code and Treasury Regulations are silent on this issue, a careful analysis of IRS rulings and case law yields some principles that can be stated with certainty.

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Vesting and 1031 Exchanges: “Same Taxpayer” Rule

Exchange Update

In order to qualify for tax deferral treatment under Internal Revenue Code § 1031, the taxpayer that sells relinquished property in an exchange must also purchase the replacement property. For example, if Alex Smith sells relinquished property as an individual, Alex Smith must also acquire the replacement property. While a simple concept in theory, investors often overlook this important detail. A variety of circumstances can arise under which vesting of the replacement property must differ from the relinquished property’s original vesting. In some cases, there are certain exceptions to the general rule that can be utilized to meet the “Same Taxpayer” requirement, as outlined here:

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The nation’s hottest housing market? Surprise — it’s Fresno

Couple on Patio

After five years of planning and months of construction delays, first-time developer Vincent Ricchiuti was ready to open his luxury apartment complex. Then came the pandemic.

“We thought it was the worst time you could imagine,” Ricchiuti said about the grand opening in spring 2020.

Turns out he didn’t need to worry. His project, The Row, was opening in the nation’s hottest housing market: Fresno.

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Like-Kind Requirements For 1031 Exchanges

Exchange Update

Internal Revenue Code Section 1031 applies only to “property held for productive use in a trade or business or for investment”. It allows for the deferral of capital gain tax if such property is exchanged solely for property of “like-kind”. Contrary to what many people believe, “like-kind” does not mean that an investor must, for example, exchange land for land, or a duplex for a duplex.

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Using Reverse Exchanges as a Tool in a Changing Market

Exchange Update

Many investors are aware of their ability to use a reverse 1031 exchange when they are faced with having to close on their replacement property before they are able to close on their sale property; however, reverse exchanges can also be used proactively when tight inventory creates purchasing challenges.

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