1031 Exchange California

1031 Exchange Rules in California

Here's what you need to know

Learn the methods used by savvy real estate investors to defer paying capital gains taxes, and build wealth. We’re talking about the IRS code Section 1031.  Get in touch with us for more details on how Section 1031 Exchange California can work for your investments.

Short answer: 1031 exchange, also called a like-kind exchange, is a swap of one investment property for another. In effect, you are allowed to defer paying taxes because you’re not cashing out on the sale.  Instead, you are putting the proceeds of the sale into another similar investment property.  Lets get into the details for more clarity.

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1031 Exchange California Steps

Navigating the complexities of a 1031 exchange in California for commercial properties requires careful planning, compliance with IRS regulations, and collaboration with experienced professionals, including Qualified Intermediaries, attorneys, and tax advisors. This strategic tool offers significant advantages to business owners aiming to optimize their real estate investments and defer capital gains taxes.

Here are the steps involved in a California 1031 exchange process:

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Sale of The Current Property

Step 1: The first step of a California 1031 exchange process begins with the sale of the current commercial property, the property that's generating capital gains, aka The Relinquished property.

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Find The Replacement Property

Step 2: Within 45 days of selling the relinquished property, the property owner must identify potential replacement properties in writing to a Qualified Intermediary (QI).

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Purchase of Replacement Property

Step 3: Involves the purchase of Replacement Property within 180 days After identifying the replacement property, the owner has 180 days to complete the acquisition

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1031 Exchange Timeline

Identification Period: Within 45 days of selling the relinquished property, the property owner must provide a written list of potential replacement properties to the Qualified Intermediary.

Exchange Period: The entire exchange process must be completed within 180 days of selling the relinquished property, or by the due date of the owner’s tax return, including extensions, whichever comes first.

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Tax Implications of 1031 Real Estate Exchange

As long as the 45 and 180-day rules are followed, no capital gains tax will be levied on the sale of the original property. This is beneficial as it allows the seller to have more liquid capital available to invest in the replacement property.

If there is a discrepancy between the original sale price and the exchange property price, known as a “boot,” the boot will be taxed. For example, if you sell a property for $100,000 and buy another property at $90,000, that $10,000 difference is considered a capital gain, and will be taxed.

There is no limit to how many times a 1031 exchange can occur, as long as the timing rules and “like-for-like” parameters are respected. That means until a property is sold for cash, in a lifetime a savvy investor can legally keep flipping properties without paying capital gains taxes.

As a qualified 1031 exchange broker Alex can walk you through the rules to follow to accomplish this.

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1031 Exchange Real Estate as a Vacation Home

1031 real estate exchanges used to often be used by savvy homeowners to swap vacation homes, or secondary residences. That is still possible, but like with the rules of a primary residence, it will take much longer. Again, the property will have to be available to renters for a set period of time, and the owners of the property can not use it for longer than 10% of the time it is rented. This will categorize the property as being for business purposes, allowing it to be used in a 1031 real estate exchange. We strongly advise you consult with a qualified 1031 exchange real estate agent if you are thinking of taking advantage of this loophole, as the repercussions of doing it wrong can be financially hefty.

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1031 Exchange Real Estate as a Primary Residence

1031 real estate exchanges used to often be used by savvy homeowners to swap vacation homes, or secondary residences. That is still possible, but like with the rules of a primary residence, it will take much longer. Again, the property will have to be available to renters for a set period of time, and the owners of the property can not use it for longer than 10% of the time it is rented. This will categorize the property as being for business purposes, allowing it to be used in a 1031 real estate exchange. We strongly advise you consult with a qualified 1031 exchange real estate agent if you are thinking of taking advantage of this loophole, as the repercussions of doing it wrong can be financially hefty.

Types of 1031 Exchanges

Simultaneous Exchange:

Both the relinquished and replacement properties are transferred on the same day. It is a less common type of 1031 exchange due to its complexity.

Delayed (Forward) Exchange:

The most common type of 1031 exchange. The property owner first sells the relinquished property and then identifies the replacement property within 45 days.

Delayed (Reverse) Exchange:

The property owner acquires the Replacement property before selling the relinquished property. Typically done when securing the replacement property is a top priority.

Improvement Exchange:

Funds from the sale are used to improve the replacement property. The property owner must identify the Replacement Property within 45 days but has up to 180 days to complete the improvements.

Benefits of 1031 Exchanges

A properly executed 1031 exchange California can offer substantial tax benefits, allowing commercial property owners to defer capital gains taxes and redirect funds into new investments. It’s crucial to work with experienced professionals, including qualified intermediaries and legal advisors, to ensure compliance with IRS regulations and maximize the advantages of a 1031 exchange.

Defer Capital Gains Tax

One of the primary benefits is the deferral of capital gains taxes, which allows property owners to reinvest the entire sale proceeds into the replacement property.

Wealth Accumulation:

By leveraging the entire sales amount, business owners can invest in higher-value properties, potentially leading to increased rental income and property appreciation.

Portfolio Diversification:

A 1031 exchange facilitates the exchange of one property for multiple properties or a different type of property, allowing for better risk management and portfolio diversification.

Alex Matevosian

Realtor® DRE 02047572 / 02211621

 Over the years, I’ve delved into the ins and outs of the LA industrial real estate market, and my knowledge of this niche is among the very best in the city.

1031 Exchange Terms and Definitions

Relinquished Property: The “down leg”

Relinquished Property is the commercial property that the owner intends to sell as part of the 1031 exchange. This property has appreciated in value, and the owner wishes to defer the capital gains taxes that would be incurred upon its sale. The successful identification and sale of the Relinquished Property are crucial steps in initiating a 1031 exchange.

Replacement Property: The “upleg”

This is the property that the investor intends to acquire as part of the 1031 exchange. It serves as the replacement for the Relinquished Property. To qualify for a 1031 exchange, the Replacement Property must be of a “like-kind” nature, meaning it should share a similar intended use with the Relinquished Property. The goal is to reinvest the sale proceeds from the Relinquished Property into the Replacement Property to defer capital gains taxes.

Qualified Intermediary (QI): An independent third party

A Qualified Intermediary (QI) is an independent and neutral third party responsible for overseeing and facilitating the 1031 exchange process. The role of the QI is crucial in ensuring that the exchange complies with IRS regulations. Specifically, the QI holds the sale proceeds from the Relinquished Property in escrow during the exchange period.

They also assist with the documentation, timing, and coordination of the exchange, helping to ensure a smooth and compliant transaction. Using a QI is a requirement to maintain the tax-deferred status of the exchange.

Boot: Cash or other proceeds

“Boot” is a term used in 1031 exchanges to refer to any property or cash received by the investor that does not qualify as “like-kind.” In other words, it is any part of the exchange that does not involve the Replacement Property.

Boot can include cash proceeds received from the sale of the Relinquished Property that are not reinvested in the Replacement Property. If boot is received, it may trigger capital gains taxes on the boot amount. The goal in a 1031 exchange is typically to minimize or eliminate boot to maximize tax deferral.

Call 818-482-3830 and speak with Alex about your California 1031 Exchange project.

1031 Exchange FAQs

There’s no specific minimum holding period mandated by the IRS for a 1031 exchange property. However, the IRS does require that the property be held for productive use in a trade or business or for investment purposes. The intent is crucial; it should be clear that you acquired the property with the intention of using it for these purposes, rather than for immediate resale.

While there’s no set minimum holding period, a shorter holding period may raise questions about your intent and could potentially lead to a closer examination by tax authorities. It’s essential to consult with tax professionals and adhere to the broader principles of holding the property for investment or business purposes to meet the requirements of a 1031 exchange.

The 1031 exchange 5-year rule, often referred to as the “Five-Year Holding Period Rule,” is a guideline that pertains to certain types of tax-deferred exchanges, particularly those involving real estate properties. Here’s what it entails:

  1. Primary Residence Exclusion: Under the 1031 exchange rules, you must hold the property you exchange for productive use in a trade or business or for investment purposes. Properties held for personal use, such as a primary residence, do not qualify for a 1031 exchange.

  2. Conversion to Primary Residence: If you complete a 1031 exchange and later decide to use the replacement property as your primary residence, you must adhere to the Five-Year Holding Period Rule.

  3. Five-Year Holding Period: To qualify for the primary residence exclusion of up to $250,000 (or $500,000 for married couples filing jointly) of capital gains tax when selling your primary residence, you must have owned and used the property as your primary residence for at least five years during the eight-year period ending on the date of the sale.

  4. Pro Rata Calculation: If you haven’t met the full five-year holding period, a pro rata calculation is applied to determine the portion of the capital gains exclusion you qualify for. This means you may still be eligible for a partial exclusion based on the time you’ve used the property as your primary residence.

  5. Exceptions: Certain exceptions may apply, such as changes in health, employment, or unforeseen circumstances, which could allow you to qualify for the exclusion even if you haven’t met the full five-year requirement.

California adheres to federal regulations for 1031 exchanges. This means that Replacement Properties must be of a similar nature as the Relinquished Property.

Using a Qualified Intermediary (QI) is mandatory in California to facilitate the exchange, hold sale proceeds, and ensure compliance. Property owners have 45 days to identify Replacement Properties and 180 days to complete the exchange.

Reporting the exchange on the California state income tax return is necessary. While federal capital gains taxes can be deferred, California may impose its own state-level capital gains taxes. Specific property type restrictions and state real estate regulations may apply, so consulting with experts in California tax laws is advisable. Compliance with both federal and state regulations is essential for a successful 1031 exchange in California.

When you sell a 1031 exchange property in California, several key steps come into play:

  1. Start with the sale of your current property, known as the Relinquished Property.
  2. Identify a Qualified Intermediary (QI) to facilitate the exchange.
  3. Within 45 days of selling the Relinquished Property, identify potential Replacement Properties in writing and submit this to your QI.
  4. Complete the acquisition of the Replacement Property within 180 days from the sale of the Relinquished Property or by the due date of your tax return for that year.
  5. The QI holds sale proceeds in escrow and ensures compliance with IRS regulations.
  6. Report the 1031 exchange on your California state income tax return.
  7. Be aware that California may impose its own state-level capital gains taxes.
  8. Comply with both federal and state regulations, including any specific property type restrictions or limitations that California may impose.

A 1031 exchange property sale offers sellers several key benefits:

  1. Tax Deferral: Sellers can defer capital gains taxes, preserving liquidity for reinvestment.
  2. Wealth Preservation: Wealth remains intact, potentially enhancing purchasing power.
  3. Diverse Investments: Diversification is possible by exchanging into different properties.
  4. Increased Cash Flow: Potential for higher income properties and increased cash flow.
  5. Portfolio Growth: Continuous portfolio expansion without immediate tax payments.
  6. Estate Planning: Deferred taxes benefit heirs on a stepped-up basis.
  7. Property Upgrades: Opportunity to acquire newer, higher-value properties.
  8. Market Adaptation: Adjust to changing market conditions or property types.
  9. Risk Mitigation: Spread risk across various properties or markets.
  10. Long-Term Benefits: Offers enduring tax savings and wealth accumulation potential.

Consult with tax and real estate professionals for effective 1031 exchange planning.

Recent 1031
Exchange Projects

1031 Exchange Building Notes:
6,801 SF Auto Repair Shop and Body Shop with spray booth and high tech equipment. 2000 sq. ft. of building is a mezzanine which is used as part storage and office. Features Building Signage and Street Signage and East Freeway Access.

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