The Treasury Department and IRS issue final regulations regarding like-kind exchanges of real property. (As of 2021)
California Tax Filing Requirement for IRC 1031 Exchanges
November 23, 2020:
WASHINGTON — The Treasury Department and Internal Revenue Service issued final regulations relating to section 1031 like-kind exchanges. These final regulations address the definition of real property under section §1031 and also provide a rule addressing the receipt of personal property that is incidental to real property received in a like-kind exchange.
The 2017 Tax Cuts and Jobs Act (TCJA) limited like-kind exchange treatment to exchanges of real property. As of January 1, 2018, exchanges of personal or intangible property such as vehicles, artwork, collectibles, patents, and other intellectual property generally do not qualify for nonrecognition of gain as like-kind exchanges. Also, like-kind exchange treatment applies only to exchanges of real property held for use in a trade or business or for investment. An exchange of real property held primarily for sale does not qualify as a like-kind exchange.
Some of the rules of a §1031 Exchange is the Seller has 45 days to identify one or any number of replacement properties from the date the original property was sold. At day 45, Seller must identify at least one replacement property and must close escrow on the investment replacement property(ies) within 180 days after the closing date of the original property that was sold for the purpose of deferring capital gains taxes. Your Escrow agent is an essential partner in reaching these deadlines and assists in closing on or before that important 180 day mark.
Real property and what it includes
Under the final regulations, real property includes land and generally anything permanently built on or attached to land. In general, real property also includes property that is characterized as real property under applicable State or local law. In addition, certain intangible property, such as leaseholds or easements, qualifies as real property under section 1031. Property not eligible for like-kind exchange treatment prior to enactment of the TCJA remains ineligible. Neither the TCJA nor the final regulations change whether the properties exchanged are of like kind.
To report a like-kind exchange, taxpayers must file Form 8824, Like-Kind Exchanges, with their tax return for the year they transfer property as part of a like-kind exchange. This form helps taxpayers figure the amount of gain deferred as a result of the like-kind exchange, as well as the basis of the like-kind property received. Form 8824 also helps taxpayers compute the amount of gain they must report if cash or property that isn’t of a like-kind is involved in the exchange.
For more information about this and other tax reform changes, visit irs.gov/taxreform.
The mandatory reporting affects “all individuals, estates, and trusts, and all business entities regardless of their residency status or commercial domicile” for all exchange transactions that occur on or after January 1, 2014, and each subsequent taxable year in which the gain or loss from that exchange has not been recognized. The report must be filed whether or not the taxpayer has any other franchise tax, income tax or any other information return filing requirement under California law.
Example of Taxes
- Taxpayer A sells a California property that closes on January 27, 2021 for $1,500,000 as part of a tax deferred exchange.
- Taxpayer A’s adjusted basis in the California property was $750,000.
- Therefore, Taxpayer A “realized” a $750,000 gain on the sale of that property.
- Taxpayer A acquires a replacement property in Texas for $2,000,000.
- With the assumption that Taxpayer A received no “boot” in the exchange, the gain deferred on California property would be $750,000.
- Under the new mandatory California tax filing requirement, Taxpayer A must report the $750,000 deferred California “tracked” gain on the new California 1031 exchange information return.
Final Rules:
If the taxpayer fails to file an information return as required, the Franchise Tax Board may make an estimate of the net income, from any available information, and may propose to assess the amount of tax, interest and penalties due to California.
For more information on the new 1031 exchange filing requirements for California, click here to read more on the California Franchise Tax Board website.
