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How to treat a 1031 exchange - Washington to California

ingridsorenson
Level 3

A client sold his Washington State rental condo in a 1031 exchange for a condo in California. I'm confused on how to treat it. Washington has no tax, therefore no capital gains on state level. Does it affect California at this point? He is a resident of California

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BobKamman
Level 15

I thought all the exchanges were going in the other direction, these days. 

California practitioners will know more about this than I do.  If the taxpayer were still a Washington resident, I would have questions about whether the basis for depreciation and eventual sale for the new property would have to be reduced by the deferred gain.  If the exchange were going in the opposite direction, California wants returns every year until the out-of-state property is sold.  They claim to be able to tax the deferred gain even 20 years later, I think. 

You don't seem to have either of those problems.  

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BobKamman
Level 15

Resident of what state?

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ingridsorenson
Level 3

California

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BobKamman
Level 15

I thought all the exchanges were going in the other direction, these days. 

California practitioners will know more about this than I do.  If the taxpayer were still a Washington resident, I would have questions about whether the basis for depreciation and eventual sale for the new property would have to be reduced by the deferred gain.  If the exchange were going in the opposite direction, California wants returns every year until the out-of-state property is sold.  They claim to be able to tax the deferred gain even 20 years later, I think. 

You don't seem to have either of those problems.  

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ingridsorenson
Level 3

Thank you for your response. I didn't think California would be involved until the new property sells in the future. I just had a mind block for a moment!

My client is heading for retirement shortly and didn't want the obligation of an out-of-state property any longer. I actually tried to dissuade him but he also had some valid reasons. 

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dascpa
Level 9

Your 1031 is going in the other direction but be aware of 1031's FROM California. California requires annual filings forever and will get their money on disposition. See below.

California regulations employ a “Claw back” provision that requires any gain in property value accrued in California be subject to California state taxes, regardless of whether or not that property was exchanged for one in another state. At the time of a “cash-out” sale the taxpayer would be subject to the state taxes in which the property is being sold, as well as to California for the taxes applicable to the gain attributable while in California, thereby creating a partial double taxation scenario. Other states that have imposed a similar claw back rule for nonresidents who have exchanged in-state properties for out-of-state replacement properties are Massachusetts, Montana and Oregon.

The State of California Assembly passed legislation adding new sections to the California Revenue & Taxation code that require that 1031 Exchange investors that sell California Property and purchase Non-California Replacement Property to file an annual information return with the California Franchise Tax Board (FTB), reporting this Non-California property. The California State taxes that were previously deferred will be due if and when taxpayers sell their new non-California properties and elect to take their profits rather than continuing to defer taxes through another 1031 Exchange.

This information return must be filed in the year of the exchange and every year thereafter in which the gain is deferred. If taxpayers fail to file the annual return, the FTB may estimate taxes due and assess tax, interest and penalties. The new law shall apply to exchanges of property that occur in taxable years beginning on or after January 1, 2014. Although the new requirement to file an annual information return with the state of California is a burden, investors still will never have to pay the California taxes due under the California Claw-Back Provisions as long as they continue to 1031 Exchange from property to property.

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qbteachmt
Level 15

"Washington has no tax, therefore no capital gains on state level."

For reference, that will not be the case starting in 2022.

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ingridsorenson
Level 3

Thank you. I read that Washington is trying to implement a capital gains tax. My client has another property there that he may want to sell

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qbteachmt
Level 15

If you do much work for WA residents:

https://dor.wa.gov/taxes-rates/other-taxes/capital-gains-tax

https://dor.wa.gov/taxes-rates/other-taxes/real-estate-excise-tax

 

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