1031 Exchange out of California clawback laws -best practices

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1031 Exchange out of California clawback laws -best practices

Wendy Stclair
Investor · Long Beach, CA · Member since 2019 · 42 posts · 63 votes

Hi

I'm in the middle of a 1031 exchange out of Cali and trying to minimize how much hassle i bring into my life with this "clawback law"  My thinking is this... can anyone confirm? If i leverage myself as much as possible and buy 6 or so multiple properties paying just the minimal downpayment, I will have many properties i eventually need to pay California tax on.  But if I just get 3 properties (of course with the required equity and boot numbers) i could buy just 3, one mainly with cash. That last one i would own outright and that would satisfy my exchange right? Then to make that money work for me later,  (maybe even soon if i wanted) i could cash out refi that property and buy more properties that would NOT be subject to the exchange.  is this flawed thinking?  thanks for any insights!  

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Al D.
Investor · San Francisco, CA · Member since 2017 · 303 posts · 327 votes
4y

@Linda West First of all, kudos to your CPA for at least being aware of the requirement since 2014. Chris is correct - it is Form FTB 3840, not federal. I’ve had to provide some of the below evidence to an EA and a CPA - as well as numerous CA investors - who had not been aware of the issue, before they would believe me:

https://www.ftb.ca.gov/about-ftb/newsroom/tax-news/February-2021/compliance-effort-for-FTB-3840-california-like-kind-exchanges-letters-continues.html

https://www.caltax.com/news/podcast/podcast-who-is-responsible-for-filing-form-3840-after-a-like-kind-exchange/

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    4y

    @Wendy Stclair, exactly right.  A cash out refi isn't taxable.  And that is a great strategy to put cash in your pocket but keep all of the gain tax deferred.  The claw back won't go away.  But as long as you own the property you'll not have to worry about it.

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  • Linda West
    Investor · San Diego, CA · Member since 2018 · 62 posts · 16 votes
    4y

    Now I'm curious -- I was told by my (CA) CPA that if I followed a similar strategy to OP's, but bought the 6 or 3 properties outside CA, I would continue to need to file a 0 tax return IN California.  Just to 'remind' the IRS about the 1031 exchange I had done.  And further, if I ever missed a year and did not file a zero return in CA for the property I exchanged out of, all the gains would be immediately due and payable.  Say it's not so.  But I bet it is ;-(

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  • Wendy Stclair
    OP
    Investor · Long Beach, CA · Member since 2019 · 42 posts · 63 votes
    4y

    Shoot -trying to clarify here - what i meant was... I KNOW i'll owe for these 3 CA properties going forward BUT my hope is that I'll pay less to Cali in the long run if i ONLY buy 3 properties with the 1031 (one with cash) then later do a cash out refi on that last one and take THAT cash to buy more properties OUTSIDE the 1031.  yes? 

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  • Liz J.
    Rental Property Investor · San Diego, CA · Member since 2016 · 10 posts · 3 votes
    4y

    Interesting. Makes me curious to know if one must proportionally split the carryover basis or if there are options there as well? Even with all that, at the end of the day I would buy the best properties that meet your goal (ie cash-flow) and if it works out to do this all cash/ refi then great. 

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  • Chris Ng
    Investor · Saint Johns · Member since 2021 · 34 posts · 16 votes
    4y
    Quote from @Linda West:

    Now I'm curious -- I was told by my (CA) CPA that if I followed a similar strategy to OP's, but bought the 6 or 3 properties outside CA, I would continue to need to file a 0 tax return IN California.  Just to 'remind' the IRS about the 1031 exchange I had done.  And further, if I ever missed a year and did not file a zero return in CA for the property I exchanged out of, all the gains would be immediately due and payable.  Say it's not so.  But I bet it is ;-(


    Yes, you need to file a specific form (can't remember the number now) as part of your tax return EVERY year until you sell or step up gain. But that's to the FTB not IRS. If you ever missed one year they will assume you have sold it and send you a tax bill. I just went through this with my accountant. 

    2Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    4y

    @Liz J., You can allocate your proceeds in any way you want on the purchases.  The basis will be spread out by an allocation that makes rational sense by your accountant.  Usually they will allocate by sq footage or purchase price.

    The 1031 Investor5137 Reviews
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  • Al D.
    Investor · San Francisco, CA · Member since 2017 · 303 posts · 327 votes
    4y

    @Linda West First of all, kudos to your CPA for at least being aware of the requirement since 2014. Chris is correct - it is Form FTB 3840, not federal. I’ve had to provide some of the below evidence to an EA and a CPA - as well as numerous CA investors - who had not been aware of the issue, before they would believe me:

    https://www.ftb.ca.gov/about-ftb/newsroom/tax-news/February-2021/compliance-effort-for-FTB-3840-california-like-kind-exchanges-letters-continues.html

    https://www.caltax.com/news/podcast/podcast-who-is-responsible-for-filing-form-3840-after-a-like-kind-exchange/

    3Reply
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