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Non-California Replacement Property Acquisitions-AB 92

Under Internal Revenue Code Section 1031, taxpayers can defer capital gains by exchanging real property held for use in a trade or business, or for investment, for other like-kind property. For sellers subject to California income tax, California’s tax law follows federal law for purposes of deferral under Section 1031, so California’s income tax is also deferred. In each case, the deferred capital gain continues as a tax attribute of the replacement property acquired by the taxpayer in the exchange.

Taxpayers who exchange out of a California relinquished property and into replacement property located outside of California have an added reporting requirement with the state of California. The California legislature passed Assembly Bill 92 (AB 92) which added “California Revenue and Taxation Sections 18032 and 24953,” to the California tax code creating a new annual tax reporting requirement for those taxpayers who exchange California property under IRC Section 1031 for non-California replacement property. The State of California’s Franchise Tax Board (FTB) released Form FTB 3840, California Like-Kind Exchanges, which requires taxpayers (California residents and non-California  residents) who sell relinquished real property in the state of California and who purchase replacement real property outside of California in a 1031 exchange to report annually the subsequent status of the non-California replacement property.

EXAMPLE: Taxpayer A sells a California property that closes on January 27, 2016, for $1,500,000 as part of a 1031 tax-deferred exchange. Taxpayer A’s adjusted basis in the California property was $750,000. Therefore, Taxpayer A “realized” a $750,000 gain on the sale of that property. Taxpayer A acquires a replacement property in Texas for $2,000,000. With the assumption that Taxpayer A received no “boot” in the exchange, the gain deferred on California property would be $750,000. Under the new mandatory California tax-filing requirement, Taxpayer A must report the $750,000 deferred California “tracked” gain on the California 1031 exchange information return, Form FTB 3840.

CAUTION: If the taxpayer fails to file an information return as required, the Franchise Tax Board may make an estimate of the net income, from any available information, and may propose to assess the amount of tax, interest and penalties due to California.

For more information on the 1031 exchange filing requirements for California, visit: https://www.ftb.ca.gov/individuals/1031_reporting_requirements.shtml

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