Considerations for Out-of-State 1031 Exchanges

By: Juno Kenny, VP, Exchange Manager at Genesis Bank

In the 1031 exchange industry, we often come across clients looking to reposition or restructure their real estate portfolios. 1031 exchanges can be an effective solution because they allow investors to preserve the value of their invested capital through tax deferral.

For instance, one of our clients recently exchanged five separate residential properties in North Carolina for a single property in San Diego, their city of residence. This allowed our client to simplify their portfolio and reduce the time, energy, and money they spent managing multiple out-of-state properties.

Because virtually all investment and commercial properties within the U.S. are considered “like-kind” to one another, out-of-state exchanges are frequently an appealing option. But there are a few caveats to bear in mind.

First, certain states have clawback provisions that allow the state to collect allocable capital gains taxes, even years after the sale. These states currently include California, Massachusetts, Montana, and Oregon.

For example, let’s say you’re a resident of Nevada and are exchanging a condo in California for one in Nevada. You realize a gain of $500,000 that is properly deferred under IRC Section 1031. Later, you sell the Nevada condo in a nondeferred transaction, recognizing a gain of $2,000,000. The $500,000 deferred gain has a source in California and is taxable by that state.

Second, tax withholding requirements vary by jurisdiction and circumstance. Some states require taxes to be withheld in certain real estate transactions, and 1031 exchanges may or may not be exempt.

Out-of-state 1031 exchanges can often be a smart move, but it’s essential to understand all the applicable laws so you don’t get a surprise tax bill. Consult your attorney or tax advisor, and contact the Genesis Bank Exchange team to learn more.