What are the key 1031 exchange deadlines?
The client must identify replacement property in writing within 45 days after closing the sale of the relinquished property, and must acquire the replacement within 180 days of that sale, or by the due date of the tax return for that year if earlier (Internal Revenue Code section 1031). Neither deadline is extended for weekends or a slow market. Because of that, our members often start scouting replacement property before the sale closes.
What kinds of property qualify?
Real property held for investment or for productive use in a business can be exchanged for other such real property; a rental house can be exchanged for an apartment building, land or commercial property. A primary residence and property held mainly for resale do not qualify. Mixed-use situations, such as a duplex where the owner lives in one unit, need to be split between the residence and the rental portion, which is a question for the client's accountant.
Why does the client need a qualified intermediary?
To defer the gain, the client cannot receive or control the sale proceeds. A qualified intermediary holds the funds between the sale and the purchase and documents the exchange. The intermediary has to be engaged before the sale closes, and the exchange language goes into both purchase contracts and the escrow instructions. Our members coordinate with the intermediary the client or advisor chooses.
What is California's 1031 clawback?
If a client exchanges California property for property in another state, California tracks the deferred California gain. The client must file Form FTB 3840 every year until the gain is recognized, and California taxes that gain when the out-of-state replacement is eventually sold in a taxable sale, even if the client no longer lives in California (California Franchise Tax Board). Exchanging into California replacement property does not trigger the annual filing.
Does California withhold tax at closing on an investment sale?
Generally, escrow withholds 3 1/3 percent of the sales price for California income tax on the sale of California real estate, unless an exemption applies or the seller elects withholding based on the actual gain. A sale that qualifies as a 1031 exchange is exempt from withholding, except on any cash or other boot the client receives. The seller certifies the exemption on Form 593 through escrow (California Franchise Tax Board).
What taxes apply if the client sells without an exchange?
The gain is generally subject to federal capital gains tax, and California taxes capital gains as ordinary income. Depreciation taken over the years is usually recaptured at a separate federal rate, and higher-income clients may owe the 3.8 percent net investment income tax. Many clients compare an exchange, an outright sale, and holding the property until death for a stepped-up basis; that comparison belongs with the client's accountant.
Can a client exchange into a smaller share of a larger property?
Yes. Some clients exchange into a Delaware Statutory Trust, a passive fractional interest in larger properties that qualifies as real property for exchange purposes. Others exchange into tenancy-in-common interests. These are securities or quasi-securities sold through licensed securities professionals, so our members coordinate with the client's advisor rather than recommend a specific offering.
How do tenants in place affect a sale?
Tenants have rights that survive a sale. Most California rentals are covered by the Tenant Protection Act, which requires just cause to end a tenancy after 12 months and caps annual rent increases at 5 percent plus the local inflation rate, or 10 percent, whichever is lower (Civil Code sections 1946.2 and 1947.12). Many Bay Area cities add their own rent control and eviction rules. Showings need proper notice to the tenant, and buyers will ask for the leases, rent roll and deposits. We gather these early so they do not slow the sale.
Which rentals are exempt from the statewide rent cap?
Common exemptions include housing first occupied within the last 15 years, and single-family homes and condominiums owned by individuals, not corporations, if the owner gives tenants the required written exemption notice. If the notice was never given, the exemption does not apply. Local ordinances may still apply to exempt units. The statewide law is currently set to expire on January 1, 2030 (Civil Code section 1947.12).
How do our members value an investment property?
For two-to-four-unit properties, buyers look at both comparable sales and the income. Our members prepare a market analysis that includes the current rent roll, market rents, operating expenses, the capitalization rate (net operating income divided by price) and the gross rent multiplier, so the client and advisor can see how the property is likely to be priced and financed by buyers.
What does the agent handle, and what stays with the accountant and advisor?
The agent handles pricing, marketing, tenant coordination, offers, escrow and the timing of the sale and purchase around the exchange deadlines. Whether to exchange, how to structure it, and the tax reporting stay with the client's accountant, advisor and qualified intermediary. Our members do not give legal, tax or investment advice.
Is there a referral fee for accountants or advisors?
No. In California, a real estate broker generally may not pay a referral fee to someone who is not licensed as a real estate broker or salesperson (Business and Professions Code section 10137), so we do not pay referral fees to accountants, advisors or attorneys.
How do I refer a client to the collective?
Send us the property location and the client's goal, and we match the client with a member who works in that county and has handled investment sales and exchanges. With the client's permission, we copy you on the dates that matter to the tax plan. Refer a client.
This page explains how these sales generally work in California. It is not legal or tax advice. Every estate and trust is different, so please confirm the details with the estate's attorney or certified public accountant.