California law obligates owners of real estate investment property in California who later acquired non-California property in a 1031 exchange to file an annual informational tax return. [1] California requires this yearly filing to track property with California sourced gains and later assess taxes when the property is sold in a taxable transaction. This law corrects a problem where taxpayers later sell their Non-California relinquished property and their previously deferred California sourced gain is not reported to California
This provision of California Revenue & Tax code is called the "California Claw-Back Clause". Because California FTB is still developing the "California 1031 Information Return," taxpayers should anticipate having to report their California sourced gains (previously deferred).
We expect California's 1031 Information Return will request the following information:
- California and non-California property address and ownership;
- Contract price for the original property purchased in California and selling price for the property sold in California as well as the property acquired outside of California in the 1031 exchange (which may involve several additional properties subsequently acquired); and
- Debt amounts each property was/is subject to;
- Amount of cash or fair market value of property received in the exchange;
- State where new real property is located.
When the taxpayer ultimately decides to sell their non-California investment real estate in a taxable transaction, the transaction will be subject to both Federal and state income taxes, which may include multiple states. Complications can also arise where one or more California investment property are exchanged in a 1031 for multiple properties within and outside of California. As an investor in California real estate, it is important to consult with an experienced tax attorney to properly plan your 1031 exchange and reporting of California sourced gains from your investments.
[1] Assembly Bill 92 (AB 92) added California Revenue and Taxation Code Sections 18032 and 24953 creating a new annual filing requirement for taxpayers exchanging California real property for non-California replacement property in a 1031 exchange.