Out Of State 1031 Exchange

It is possible to trade into property located in another state. Under Internal Revenue Code Section 1031, real estate located in one U.S. state is like-kind to real estate located in any other state, and you can trade from one state to another. In most cases you are able to defer both federal and state tax, assuming the state has an income tax.

Many real estate investors are unsure if they can use a 1031 exchange when selling property in one state and purchasing another in a different state. Fortunately, for all the investors out there, moving markets is not an issue when it comes to 1031 exchanges. You can sell an investment property in one state and use those funds to purchase property in another state within an exchange. This transaction is commonly called a state-to-state 1031 exchange.

Many states have withholding requirements when an out-of-state investor sells the property. Typically, these rules require the closer to withhold a percentage of the proceeds and remit them to the taxing authority as a type of security or deposit on the tax that will be paid once a tax return is filed. Some states have exceptions to withholding if you do an exchange, and different states have different requirements for paperwork and timing to take advantage of this exception to withholding.

There are what is called “Claw-back” provisions that are an example of an exception to the scenario described above. In states with claw-back provisions, if the replacement property is later sold in a taxable sale, the original state it was exchanged out of, as well as the state it was sold in, will collect taxes on the sale.
The following states have claw-back provisions in place:

  • California
  • Oregon
  • Montana
  • Massachusetts

There are also states that have withholding requirements if the seller of a piece of property in these states is a non-resident of any of the following states: California, Colorado, Hawaii, Georgia, Maryland, New Jersey, Mississippi, New York, North Carolina, Oregon, West Virginia, Maine, South Carolina, Rhode Island, Alabama, Delaware, and Vermont. Some of these states may have withholding exemptions for taxpayers selling their property using a 1031 exchange.

A state-to-state 1031 exchange can work for you or it can work against you. The key is to know how the states you’re dealing with treat these transactions.

If real estate investors are residents of or are considering exchanging out of or into one of the states mentioned above, it is important to understand how state-to-state 1031 exchanges work and to be aware of claw-back provisions and withholding requirements. This is not only for the current exchange but for any future exchanges as well.

For more information on purchasing a home in St. George and surrounding areas please contact us any time.

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