by Dwaine Clarke

December 12, 2021

Big Building

As a real estate investor, you might probably have come across the term “1031 exchange”. Suppose you want to sell off your current property and buy another one; this process will be the best option for you. 

A 1031 exchange allows you to defer your capital gains taxes when buying another “like-kind” property. Due to its enormous advantages, many successful real estate investors have adopted this tax-deferred sale mechanism.

However, many real estate investors are still unsure whether they can adopt this exchange transaction process when buying a property in one state in the US and selling in another state. Fortunately, moving markets isn’t an issue in 1031 exchanges. Thus, you have nothing to worry about here. 

You can sell a property in your state and buy another from a neighboring state in what is called a state-to-state 1031 exchange.

However, to get the best of the transaction, you’ll need the services of a reputable “Qualified Intermediary,” a professional third-party agency that accommodates the process, helping you avoid critical mistakes that might compromise your tax-advantaged sale. 

Suppose you’re considering a state-to-state deal and wondering what the rules entail in the following states; you’ll get all your answers here.

1031 Exchange Rules in Florida

Florida has many 1031 tax code, one of which is that the exchanged assets must be like-kind, meaning they should be similar in character or nature. The property can be single-family rental properties, vacation home rentals, restaurant property rentals, commercial office building rentals, apartment buildings, and duplexes. Don’t forget that all assets for the deal must be in the US, although you can swap an investment property in Florida for like-kind property in another state. 

You can also relinquish more than one of your assets for more than one other property in Florida. However, ensure to invest the money in a greater or equal value property for income taxes deferral when it’s eventually sold.

1031 Exchange in California

In California, the IRS 1031 process are similar to what is obtainable in other states. Nonetheless, California enforces a clawback rule when replacing properties from neighboring states. 

Thus, property investors in California can’t avoid tax when they swap their real estate outside the state. Investors with assets outside the state are required to maintain updated tax information with California, ensuring that the state gets capital gains tax when they sell their replacement property. 

The capital gain tax of investors that invest in properties outside the state would be taxed twice during clawback. Besides the tax from the property’s new location, you’ll have to pay the amount deferred when your property was in California. 

Furthermore, real estate investors will need to file a state tax return each year they defer their gains. Ensure you file a form FTB for any of the state taxes you’re paying.

1031 Exchange Rules in Texas

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According to the Texas 1031 IRC, your relinquished property must be held for investment or used in your business/trade and not a private one. On the other hand, the real estate you intend to buy, otherwise called replacement property, must not be used as personal property. However, both the relinquished and replacement properties mustn’t be inventory or dealer property (real estate held mainly for resale). 

For the deal to be completely tax-deferred, the replacement property’s purchase price must exceed or at least be equal to the relinquished property’s selling price. More so, it’d help if you didn’t accept cash at the sold property’s closing. 

Any unlike-kind property or cash received in the swap is called boot and might lead to taxable gain in state return. Received boot might not be fully taxable if some law exempts the profit from taxation or less than the profit from the transaction when selling property.

1031 Exchange Rules in Hawaii

Your replacement property’s title in Hawaii will need to be taken the same way as the relinquished property. For example, suppose a couple owns properties as tenants in common or in joint tenancy; they should get the replacement either as tenants in common or joint tenants.

However, the replacement property should be like-kind, meaning any real estate used for business, investment, or to generate income. A condo in Kaneohe can replace a vacant land in Waikiki once they’re both for investment.

A taxpayer can swap property for more properties once the new real estate is worth more in value than the old one. That way, there won’t be any tax. While you can swap a business property with an investment property, it doesn’t apply to a personal residence.

Any boot received will be taxable, which is fine if the seller is okay with paying some taxes. Else, it’d be wise to avoid boot for a 1031 deal to be completely tax-free. 

1031 Exchange in Washington State

Under the Washington state law, a qualified intermediary or exchange facilitator can maintain either a qualified trust with the client’s consent during withdrawals or a fidelity bond of 1 million dollars or more protecting clients’ funds in an escrow account. 

You’ll need to deposit the funds separately in an identified account using your taxpayer identification number. After that, you’ll receive written notification of the funds deposit.

The exchange facilitator or qualified intermediary (IQ) will provide written direction on independently verifying the funds deposit. Washington State doesn’t regulate QI services, and thus, the client is responsible for determining the exchange funds and how to hold them. 

1031 Exchange Rules in New York

Like other 1031 exchanges in the US, the New York process remains the same except for non-resident investors. A non-New York resident wishing to perform a 1031 swap will pay a 7.7 percent state income tax on their profit.

Fortunately, non-resident New York investors can avoid this by applying for a state tax exemption. Simply fill out the New York Form IT-2663 and indicate that you’re using the properties in a like-kind exchange and, thus, should be exempted. 

New York assesses your Real Estate Transfer Tax (RETT) anytime you receive a property. Investors in New York have expressed concerns that the state 1031 deal may trigger the transfer tax, seeing as in a 1031 deal, you’ll need to purchase the replacement property, then a QI will hold it before transferring to the taxpayer.

Given this concern, the New York tax authorities in 2016 confirmed that RETT doesn’t trigger a reverse 1031 deal. Thus, the investor will still get the total tax deferral attributed to a 1031 swap.

1031 Exchange Rules in Maryland

Tax Time Sticker

Maryland doesn’t recognize 1031 exchanges as tax-deferred and offers an exemption to its collection at closing. Taxpayers that intend to swap the property in the state of Maryland can file for Form MW506AE for exemption. 

When completing the form, the taxpayer should check the box showing that it’s a 1031 sale. However, to qualify, you’ll submit the document alongside a letter from a QI confirming that it’s for a swap. 

Every QI helps their clients with this process, including submitting the form to the state of Maryland Comptroller for taxpayers alongside the required cover letter. 

Presently, the state of Maryland law requires that the taxpayer submits the form under 21 days before the property’s transfer of ownership, unlike the 45 days replacement identification in other states. Thus, you need to plan and fill the form on time.

1031 Exchange Rules in Colorado

Like in most states, properties for 1031 exchanges in Colorado must be held for investment or business purposes and should be like-kind. More so, the entire amount from the sale must be used to buy a replacement property for a taxpayer to defer the capital gain taxes entirely. 

In other words, the standard 1031 code apply in Colorado. Failure to meet the timeline will lead to your 1031 disqualification, meaning you get to pay capital gain taxes on your property’s sale amount. 

There were previously no regulations in Colorado about QI requirements until 2009. However, in 2009, the state set up some consumer protection laws, stating that qualified intermediaries must maintain an omissions and errors policy of not less than $250,000 and a fidelity bond of at least $1 million.

They also need investors’ written authorization to withdraw from the escrow account if it holds more than $250,000.

1031 Exchange Rules in Pennsylvania

While at the federal level Pennsylvania ultimately recognized the IRC 1031 law, the state doesn’t adopt its provisions in its tax law. Thus, taxpayers with properties in Pennsylvania who wish to sell their property must report the entire gains in the income tax form.  

Its interpretation of the Section influences Pennsylvania’s stance on the Section 1031 process. Interestingly, when the IRS created Sec. 1031, the initial plan was for it to be a vehicle for deferring taxation of reciprocal real estate transactions, which means that a taxpayer will swap one property for another (direct swap). Direct exchange was possible in the early years; however, it isn’t so common now. 

While Pennsylvania believes reciprocal exchanges have a rational foundation, the state sees a non-reciprocal or reverse exchange as a means to allow taxpayers to defer capital gains that should be recognized. Thus, as at the time of writing this report, Pennsylvania doesn’t recognize 1031 sales for state income taxes purpose, although plans are already in motion to fully adopt Section 1031 in the state.

1031 Exchange Rules in Georgia

The Section 1031 process in Georgia are the same as in other states. However, a non-resident sale of property in Georgia might trigger a withholding tax depending on the seller’s profit or sales price. By non-residents, we mean corporations, limited liability partnerships, individuals, unincorporated organizations, limited liability companies, trusts, and cooperations. 

The state tax withholding rate is three percent of the seller’s profit or sales price. However, the seller must complete form IT-AFF2 (Affidavit of Seller’s Gain) from the Georgia Department of Revenue attesting to the taxable gain amount. 

There are withholding exemptions, especially if  the building qualifies as a primary residence or rental property under the IRC. For example, the withholding exemption applies to the taxable sale gain excluded from Federal AGI under the IRC. 

Transactions less than $20,000 are also exempted. Any swap involving like-kind properties with the sale income not subjected to either state or federal income tax is also free from withholding requirements.

1031 Exchange in New Jersey

Calculating Taxes

The state Section 1031 process allows you to postpone making payments on the profit gotten from selling your investment or business property if you’ll reinvest the profits in a qualifying like-kind property. However, your profit is still not tax-free.

New Jersey allows you to include both like-kind and unlike-kind real estate, like a rental property in your deal or add liabilities and cash to the exchange. However, it might trigger taxable gains in the exchange year if you receive relief from debt, money, or any unlike-kind property during the deal. 

It’d be best to work with an expert real estate broker like Dwaine Clarke of NNN Deal Finder when trying to exchange properties in the state, seeing as the process is tricky, especially if you have both recognized and deferred gain when selling property. 

Can you do a 1031 exchange in a different state?

The answer is yes! State income tax enables investors to relinquish their property in their location and use the proceeds to buy another in a neighboring state as seen in the following states we mentioned.

Which states do not allow 1031 exchanges?

Pennsylvania has still not fully recognized the IRS  Section 1031 because its Income Tax (PIT) doesn’t follow federal taxation principles. However, some states like New York, Maryland, New Jersey, and California have modified their 1031 process regulations.

Conclusion

As a savvy investor enjoying the benefits of 1031 exchanges, you may have considered the possibility of exchanging properties from one state to another. Hopefully, you’ve learned how a state-to-state 1031 swap works, the different rules, including the tax withholding requirements and clawback provisions. 

This knowledge will come in handy not only for any current exchange but also for future transactions. Ensure you work with a reputable QI like Dwaine Clarke of NNN Deal Finder to help you with the entire 1031 process. That way, you get a seamless transaction without falling into the numerous tricky loopholes of state-to-state 1031 codes and still end up getting taxed.

About the author 

Dwaine is the Founder and President of NNN Deal Finder an investment real estate services firm exclusively focusing on Single and Multi-Tenant Net Lease Properties. The firm provides a full range of brokerage and advisory services nationwide to High Net worth Investors, Developers, REITs and Institutional Investment Funds. Contact Dwaine to discuss securing your next investment.

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