Three questions for my first 1031!

[Danny Nikolai]

Hey BP community, 

I'm hoping to 1031 a property from California into a state with no income tax, and am planning on relocating most of my estate into this new state over time. I have three questions about completing this 1031...

1. 1031's must be exchanges of "like" properties. Can I sell my existing property and use a portion of the proceeds to purchase undeveloped land and the other portion to develop that land? Or is the money required to develop considered part of a boot that is subject to capital gains tax?

2. If I sell my property in California and then find two properties elsewhere whose values are greater than or equal to the sales price of my first property, can I do a 1-for-2 type of exchange with a 1031?

3. If I have a cash boot left over after an exchange into a different state, is that boot subject to the income tax rate in the new state or the old state?

Thanks in advance! I'm looking forward to learning more on this journey. 

[Bill Exeter]

Hi @Danny Nikolai, 

California has what we refer to as the California Claw Back.  California takes the position that if you 1031 Exchange out of property in California into property in another state it is tax-deferred but you will still owe California taxes if you ever sell, cash out and pay the taxes.  California put in reporting requirements so that you must report the status of the new replacement property to California each year even if you completely move out of the state.  

Like-kind property means that you are selling real estate and must 1031 Exchange into real estate as long as the properties sold and ultimately acquired are held for rental, investment or business use.  You can acquire vacant undeveloped land and then use the remaining portion of your proceeds to improve the land.  It is referred to as an Improvement 1031 Exchange or Build-To-Suit 1031 Exchange.  These are more complicated because the Qualified Intermediary must acquire and hold or "park" legal title to the replacement property during the 180 calendar day exchange period.  

You can sell one relinquished property and acquire two replacement properties.  The 1031 Exchange is a great strategy when you want to diversify your investment from one into two properties.  

The cash boot would only be subject to taxes in the state where the relinquished property was sold.