Understanding 1031 Exchanges in California — 2024 Complete Guide

A 1031 Exchange, or a Like Kind Exchange, as it implies, allows you to defer paying capital gains tax on the sale of a business or investment property by reinvesting the proceeds in other real estate. A Like Kind Exchange is defined by Internal Revenue Code (IRC) Section 1031.

A 1031 Tax Deferred Exchange offers taxpayers one of the last great opportunities to build wealth and save taxes. By completing a 1031 Exchange, the Taxpayer (“Exchanger”) can dispose of investment or business-use assets, acquire Replacement Property and defer the tax that would ordinarily be due upon the sale. 1031 Exchanges have been part of the tax code since 1921. Section 1031 has permitted a taxpayer to exchange business-use or investment assets for other like-kind business use or investment assets without recognizing taxable gain on the sale of the old assets. The taxes which otherwise would have been due from the sale are thus deferred.

When to Consider a 1031 Exchange?

Put simply, you can do a 1031 Exchange or consider a 1031 Exchange when you do not live in a property you own and would like to sell the property and use those proceeds in a new real estate endeavor.

Types of 1031 Exchanges:

• Simultaneous Exchange
• Leasehold Improvement Exchange
• Forward/ Delayed Exchange (Most Common type of Exchange)
• Reverse Exchange
• Improvement/ Build-to-Suit Exchange

What Qualifies as a 1031 Exchange?

Until December 2017, some personal property exchanges, including franchise licenses and equipment, qualified as 1031 exchanges. But after the Tax Cuts and Jobs Act (TCJA) was passed, only real estate qualifies.

However, exchanges must be between like-kind properties, which the IRS defines as properties “of the same nature or character, even if they differ in grade or quality.” This doesn’t mean that you need to trade one warehouse for another.

This just means that both properties involved in the exchange must be held for investment, business, or trade and be used for the same purpose. For example:

• Exchanging one shopping center for another qualifies
• Exchanging an office building you’ve been leasing to businesses for an industrial building qualifies.
• Exchanging land used for commercial purposes for a warehouse building also qualifies

1031 Exchange Benefits

Here are the main benefits of the 1031 exchange tax break:

1. Deferring taxes frees up more capital for you to buy your replacement property.
2. Depreciation recapture taxes will be deferred as well. When you cash out, you’ll be taxed a maximum of 25% which could otherwise be up to 37%.
3. You can trade one property for multiple properties in different markets (within the US) to diversify your investments.
4. You can also exchange multiple properties for one if you want to spend less time managing your rentals, for example.
5. You can trade your property or portfolio of properties for other(s) with higher returns, lower volatility, or with better cash flow that generate greater returns over time.
6. You can use 1031 exchanges to plan your estate. Tax liabilities end with death, meaning your heirs won’t have to pay your deferred capital gains tax.

What Are the 1031 Exchange Rules in California (2024)?

In 2024, the rules for 1031 exchange in California are:

1. You must purchase a like-kind property
2. Your new property must be of equal or greater value (to fully defer tax)
3. You must invest all the money you made from the sale
4. The new property must stay under the same taxpayer’s name
5. You must meet the two deadlines (we’ll go over them in the following section)

What’s The 1031 Exchange Timeline or Deadline?

Since it’s very unlikely that the person selling the property you want also wants to buy the one you’re selling, most exchanges are “delayed.”

This means that a Qualified Intermediary (QI) or a 1031 exchange intermediary will hold the cash from your sale in escrow and use it to buy the replacement property for you. But there are two deadlines or time limits to fulfill:

• You have 45 days to tell your QI (in writing) what property/ies you want to buy
• You must purchase the new property within 180 days

To clarify, the 45 days are included in the 180. You have up to 180 days to finalize the whole process from the day you sell your property.

You can also do it the other way around — buy the property you want, name the property you want to sell in 45 days, and sell it within 180 days.

Are There 1031 Exchange Fees and Closing Costs?

There are quite a few fees and closing costs you’ll have to pay. The good news is that most are tax-deductible or at least not tax-liable.

Here’s the general overview of what the 1031 exchange costs can be (on average):

• Total exchange fees: $600-$1,200
• QI fees: $750-$1,250
• QI fee per extra property in the exchange: $300-$400
• Appraisal for purchase contract: Around $5,000
• Inspection fee: $0.1/sqft
• Prorate taxes: Up to 110% of the last known county bill
• Recording fee: $200 to thousands
• Title insurance: Starts at 1% of the property value
• Loan acquisition fees for the new property: Varies
• Escrow fee: 1-2% of the total property value
• Transfer taxes: 1-3% of the total property value
• Attorney fees: Depends on your attorney
• CRE broker commission: 4-8% of the total property value

What Is the Two-Year Rule for 1031 Exchanges?

The two-year rule for 1031 exchanges mandates that all parties involved in an exchange hold their properties for a minimum of two years, starting on the day the last property transfer in that trade happens. If not, the exchange will be disallowed.

Nick Dias Real Estate Services Inc. and Nick Dias do not provide legal, tax, or investment advice. Any published articles, blog posts, resources, or other related material located on this website are for information purposes only. Please seek the advice of an attorney, tax professional, and/or financial advisor for legal, tax, or financial advice.