1031 Exchange Requirements – Does Your State Qualify?

David Moore: Hello, David Moore, Equity Vantage, 1031 exchange.com. We’re going to talk a little bit about state issues, just a small little segment. Something to be aware of and something to think about. So, we have lots of transactions going on these days where we’ve got changes of ownership, reset periods. We might have situations where we’re doing an improvement exchange.

Now, if you look at 1031 in, traditional context it’s a swap, right? You’ve got something, I’ve got something, and we swap those properties that, that, for that to work, we’ve got to have assets that are obviously of like kind and similar values and equities, how often are you going to find that situation?

So, an exchange in today’s context is really a three-way exchange. We’re an exchange facilitator. You pay us a fee to take your sale and purchase and turn it into an exchange. Now, in traditional thought, once again, and even with a third party, you’re thinking in a delayed exchange format, meaning that you’re going to put a property in the market, list it for sale.

When you get that sale pending, you’re going to reach out to us soon as escrow’s open. Give us information regarding that sale. Who’s handling the escrow, the escrow number, and the phone number. Your name, address, phone number, and email address.

Obviously, we want to talk to you about what’s going on, but one of the things we want to know is where are you, you know, where’s the property that’s being relinquished? Where’s the replacement property? And, the reason we’re going to talk a little bit about states these days is if we have changes in ownership, for example, then you’ve got, we, we just did a segment on drop and swap, swap and drops a little bit where we’re resetting.

Holding periods, let’s say. Now, is there risk in those things? And I said yes, and there’s more risk in states that have a state tax than states that do not. So, you know, if you ever were looking at a map of the United States and looking at the red and blue states, the reality of today’s world is, we’ve got lots of rent control refugees going from blue states to red states for just the rights of ownership. But a lot of those red states are so, popular. Another reason people are going there, in addition to having some ownership rights is they might not have a state tax or reduced state tax. And why that’s important is it used to be possible you could exchange out of, let’s say, California into Nevada, Texas, you know, Washington state, someplace like that, and you would be able to defer all your gains out of California to those states.

Now, you know, in the late ’90s, Oregon had a lawsuit that changed things on the state level. Because it, there was a discrimination between residents and non-residents with tax treatment of exchanges out State of Oregon. Well, the state constitution, Oregon prohibits discrimination between residents and non-residents. So, what would happen is, pre this lawsuit you’d exchange out of Oregon into, let’s say Nevada, hold the property for a year or So, sell it, and then you would get rid of the Oregon tax at, let’s say 9% at that point in time. It made sense for a period of time till Oregon figured that out. So, the way the law is today, Oregon has a claw back. California saw Oregon put this law forward, and California put the same thing in there. Now, why it’s say that’s important is, is if you want to save yourself some money on taxes. It used to be a great idea.

You’d exchange out of the state, as I said, hold it. For a year or So, then sell and take the exclusion. Today, you can continue to maintain tax deferral if you’re doing exchanges, but if you just think, hey, I’m going to exchange out of let’s say California, Oregon, and into one of these zero tax states and save myself 10%, it doesn’t work. They’ve got claw backs in place. So, basically both states are going to honor 1031 as long as you do 1031 exchanges. But if you do the exchange into one of these zero tax dates and at a later date decide, well, gee, I’m going to sell now this great idea. I saved myself that 10% roughly. That doesn’t work any longer.

So, both those states do have the right to claw back the gains that were deferred out of them, and it’s not going to cost you more, but you’re just going to have that tax exposure. Now, another one of these “great ideas” that used to work. Is if we’re converting assets. Now think about section 121 250 or 500 and what happens there. Now we’ve got, if you check out our YouTube channel type in Equity advantage what are you selling? What do you want it to be? It’s going to talk about converting assets back and forth. But I’m just going to talk about real quickly again, because people think they got these great ideas, they used to be great ideas.

They don’t work anymore. So, what I’m talking about right now is there’s lots of reasons to convert a primary residence into an investment. And, that biggest reason is that you’ve got gains in excess of 250 or 500 that Section 121 allows you to have, now, those numbers meant something in the late ’90s, they don’t anymore. So, we’ve got lots of situations where people are going to convert their primary residence into an investment property. Let’s say hold it for a year. They still are entitled to the exclusion and then they 1031, the overage. If you don’t want to do that, you don’t have the time. The other option to get out. Get away from some and to mitigate some of the tax consequence on a home sale with gains in excess of 250 or 500 is to do a QOZ/OZ qualified opportunity zone or opportunity zone for the overage beyond the 250 or 500, and you get some preferential tax treatment there.

And, the great thing about an OZ is. I look at them sort of like Roth IRA is you’ve got limited deferral into that thing, but if you hold it through its maturity, that 10 year hold, whatever you make on that OZ project’s going to be tax free. So, that’s something that’s there if you’re, you know, in a high tax state, converting assets. We’re looking at a situation where your home’s going to have that huge gain. Well, on the acquisition side, we have people that want to go buy something and convert that investment to a residence. Now, I can give you a core case where four months was deemed long enough. I’m not going to tell you that is, I’m probably going to tell you a year based on two factors that’s been proposed a couple times, and that’s where the break between short, long-term tax rates on assets held for investment is now, I said held for investment because 1031 applies to assets that were acquired with the intent to hold for investment and have been held for investment.

So, understand that flipping property does not fit 1031, you’re going to pay normal income tax on those dispositions, and you’re not going to have the ability to do an exchange. Now, that’s not to say if you bought something with the intent to hold and you haven’t done this stuff in the past and you got an unsolicited offer, that’s too good to pass up. You can take advantage of that, but that’s a conversation you’re going to have with your tax people. If you want more information and holding periods, give us a call. We’ll get some information out for you. But in that scenario where you’re buying a property, With the intent to convert it from a, let’s say, an investment to primary residence, and then you think, well, hey, I’ve got that great idea. I’m going to sell it and pay no tax per section 121. That doesn’t work.

It hasn’t worked for a long time. First government put a five year hold on. On that acquisition property. So, if you bought a property converted from investment to residence, if you sold it inside five years, it’s a fully taxable sale. And then in ’08 they put the housing assistance tax act in place, which, which really allows prorations the 250 or 500 and those prorations attributed, you know, the gain that’s attributable to qualified use versus non-qualified use. So, if you’ve got questions on this, Please don’t hesitate to reach out and, and give us a call. And we’ve got great information on it. We can get it to you. Go sit and talk with your tax people. But all these things, the government figures this stuff out over time and, they sort of plug those holes.

So, at this point in time, once again, we’re, we’re talking August of 2023. Every state in the union actually does honor 1031. Pennsylvania was the last one. Sort of a holdout, but everybody, everybody honors 1031. You know, one of the, the reasons it’s probably zero tax state’s. Another reason those states are popular in the acquisition is if you’re having some tax issue, potentially you don’t have the State Department of Revenue chasing you in addition to the IRS. So, that’s something that people are talking about, thinking about with respect to some of these changes and doing some of these things. So, hopefully I’ve answered some of your questions. David Moore, Equity Vantage 1031exchange.com. Look forward to talk with you soon. Thank you.