Understanding 1031 exchange options is a critical part of investing and planning. Because the process is complex and requires excellent planning, it’s best to consult professionals to help. David Moore of IRA Advantage and Tom Moore of Equity Advantage examine what is involved with doing 1031 exchanges across state lines and whether it is possible to buy foreign properties.
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Can I Acquire 1031 Exchange Replacement Property in a Different State or Country?
David: Today I am asking my brother and partner, Tom, the questions—it’s Ask the Experts between the brothers. So, Tom, do 1031 Exchange Options allow me to acquire the replacement property in a different state than the state where the property is relinquished?
Tom: The short answer is yes. Section 1031 is a federal tax code, so it is recognized in all states, so you can exchange from state to state. We regularly are dealing with transactions from our home state of Oregon and into California, Washington, and vice versa. We do a lot of transactions on the East Coast, including New York, New Jersey, Florida, and Maryland.
David: How about foreign properties?
Tom: No, you cannot exchange domestic for foreign. If you’re exchanging out of property in the States, you cannot go into a foreign property. However, you can exchange foreign for foreign. Foreign for foreign is considered like kind, just not domestic for foreign.
What About Taxes?
David: Are there any other things that investors need to be aware of? Any other guidelines that might hit them? If we’re in a state-to-state exchange, is there anything if you’re going to leave Oregon and you think, “Hey, I’ve got a great idea, I’m going to exchange out of California or out of Oregon with state tax and go into Nevada or Washington State or Texas or Florida where there’s no state tax. And hey, I’m going to save myself 10 percent.” Is that something that’s going to work or what happens?
Tom: Yes, it is a tax-deferred exchange, and ultimately, if you end up selling those properties in a state in which you have no state income taxes, you are still going to end up having to pay the capital gains taxes for that state in which you deferred out of.
David: Oregon and California keep their hand in the cookie jar, sort of. You can exchange out, but you’re going to defer everything as long as the tax can be deferred. But if there’s a future sale that triggers gain, they’re going to get it back?
Tom: At that point in time, yes, they will.
David: They keep that hand in that cookie jar.
Tom: Yes. They want their tax dollars. The other thing to keep in mind if you are selling different properties, different states have different rules on nonresidents of the state. Oregon has nonresident withholdings for four people selling properties. If they’re nonresident selling property here, then they have a withholding, but you can have that waived. If you’re doing a 1031 exchange transaction and you expect to defer all of your capital gains taxes, then you can have the withholding of the expected taxes waived. There’s a form that is filled out by escrow, typically at closing, if you’re doing a 1031 exchange to have the withholding waived, and it’s similar in most states. If you are selling a property in another state, you always want to find out if there is withholding. Look into whether there is a waiver for that, and typically there is for a 1031 transaction.
David: Since we’re discussing withholding, let’s talk a bit about FIRPTA, the Foreign Investment Real Property Tax Act. We have to wrestle with that every so often, and it’s something that you want to talk to your tax people about sooner rather than later.
Tom: If you’re foreign or selling domestic property here and FIRPTA kicks in, it’s something you have to plan for it because it oftentimes can take three months or so to get the waiver for that. There’s certainly paperwork that has to be filed prior to going into closing. If we get a call from somebody who wants to do an exchange transaction and they’re a foreign party selling property here, chances are those funds will be withheld at closing and then they’ll have to come in with additional cash on the acquisition side so that when those funds do get released to them, they can have that.
David: What you’re saying is if we’re in a situation where somebody hasn’t sufficiently planned ahead, then FIRPTA could trigger a withholding that it’s going to pull some money out that would be looked at as boot, unless you put some funds in to offset it. Right?
David: The taxpayer typically is going to put the money in that would be representative of what was withheld, to complete the transaction. Then when the withholding is approved (if it’s approved), then they get the funds back, but otherwise, they’re going to have tax exposure if they don’t supplement with that additional money. What you’re saying is you’re going to have tax exposure. This is very important to understand.
Tom: As you said, it’s planning. Planning is big in any 1031 exchange and, unfortunately, it doesn’t always happen. So anytime you’re contemplating a sale, get in front of your tax advisors and talk to your escrow officers too to find out what sort of withholdings they expect to have, if any, at a closing.
Navigating 1031 exchange options takes a professional, and you can count on the whole team at Equity Advantage to help. Your investments are just too important not to have an expert on you team. Give the folks at Equity Advantage a call, 503-635-1031, to get started!