If you are an investor or business owner, you will, of course, want to get the greatest amounts out of your various assets. When it is time to trade up to something else, such as larger business premises or a bigger investment property, you could find yourself liable to pay tax on any profit that you have accrued. That is unless of course, you opt for a 1031 exchange.
A 1031 exchange is a transaction during which you can swap your investment or business property for one that is ‘like-kind’, and in doing so, defer all of the tax that would otherwise be due on the sale. This includes capital gains tax, depreciation recapture tax, and state income tax. The great thing about this is that you can then use these funds, which can be substantial, towards your next investment.
Can a 1031 exchange advantage be valid in California?
Many people investors and business owners living in California are a little dubious about the possibility of utilizing a 1031 exchange for their property transaction. There is good reason for this. Although California law has always conformed to Section 1031, in the past, the California Franchise Tax Board (FTB) has taken a much more restrictive view to the mandate. This is particularly the case when it comes to drop-and-swap exchanges, in which the FTB has managed to disqualify a number of attempted 1031 exchanges by asserting the step transaction doctrine.
The step transaction doctrine was conceived to prevent people from abusing the 1031 exchange advantage and is based on the idea of viewing a transaction in its entirety rather than in the individual steps or component parts that comprise it. Fortunately, since 2015, the California State Board of Equalization (BOE) has overruled the FTB’s disallowance of like-kind exchange treatment under Section 1031.
The benefit of hiring a 1031 exchange intermediary
In theory, a 1031 exchange is a fairly straightforward process. However, you do have to hire a qualified intermediary to handle the exchange on your behalf. They will finalize the sale of your existing property, hold the funds and use it for the purchase of your like-kind property. However, this isn’t the only reason why you should consult with an intermediary.
Since a 1031 exchange offers massive potential savings, you want to be certain that you get every aspect perfectly right so that you don’t receive an unexpected visit from the IRS down the line. There are various rules and regulations surrounding the implementation of the 1031 exchange and a qualified intermediary can help you negotiate all of these and ensure that your exchange meets all of the necessary requirements.