The state of California (CA) has introduced a new annual filing requirement (under California Revenue and Taxation Code §18032 and 24953) for taxpayers who use Internal Revenue Code (IRC) Section 1031 to defer gain or loss from the sale of Californian real property.
Both U.S. and Canadian clients have concerns about this new requirement, and as such the chartered professional accountants at AG Tax have examined the form and summarized the relevant points in the following paragraphs.
California Form 1031 Information Return
The new CA 1031 information return is required to be filed by taxpayers carrying out a like-kind exchange (i.e. disposing of relinquished property [RQ] located in California in exchange for non-Californian replacement properties [RP]) and filing federal Form 1031 to defer gain and losses from this sale. This new law would help the Californian Franchise Tax Board (FTB) keep track of California-sourced gain deferrals from 1031-exchanges.
Please note that only a draft version of the CA 1031 information return has currently been released and the final format has yet to be finalized.
Purpose of the new filing requirement
The CA FTB states that gain or loss from the exchange of property located in California is California-sourced income and must be reported to the FTB when the gain or loss is ultimately recognized (i.e. when the replacement property is sold off, even if non-CA). This happens whether or not the taxpayer is residing in or doing business in California at the time the gain is recognized.
For example: An individual sells a CA RQ for $450,000 in mid-January of 2014, as part of a 1031-exchange. The adjusted cost basis of the RQ is $100,000, realizing a capital gain of $350,000 from the sale. The individual in exchange acquires a non-CA RP at a total cost of $500,000. Assuming no other property in this transaction, the individual can defer the gain of $350,000 by filing federal Form 1031. Under the new California law, they must also report this deferred $350,000 on the new CA 1031 information return in order to keep the CA FTB informed, as it is a California-sourced gain.
Properties excluded from Section 1031 treatment
• Inventory or stock in trade
• Stocks, bonds, or notes
• Other securities or debt
• Partnership interests
• Certificates of trust
Who must file?
All individuals, estates, trusts, or business entities, irrespective of their residency status or commercial domicile, must file CA Form 1031 for exchange/replacement of CA property with non-CA RPs under IRC Section 1031 occurring in taxable years from January 1, 2014 onwards.
When to file?
Taxpayers who file a California franchise tax, income tax, or information return, must file the new CA 1031 information return as an attachment to these filings. Taxpayers who do not have any of these filing requirements should file the CA 1031 information return on the same day as if they had to file the above returns.
Additionally, the CA 1031 information return needs to be filed with the FTB in the tax year in which the exchange occurs and for each following tax year in which the gain or loss is not recognized.
Penalties, in case of negligence
A Notice of Proposed Assessment may be issued to adjust the earlier deferred CA sourced gain in case of failure to file the CA 1031 information return. Additionally, penalties and interest may apply.
The FTB has been given authority by the Californian legislature to establish guidelines, procedures and standards for implementing this new law and identify ways to ease the filing requirement for taxpayers. Although the form is currently under review and the final format has yet to be disclosed, it is understood that this would be a mandatory filing for all residents and non-residents disposing of property located in California using Section 1031. Compliance is necessary to avoid any undue tax consequences.
AG Tax LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of U.S. and Canadian tax laws as well as cross-border compliance
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
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- U.S. Personal and Corporate Taxation
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- Retirement planning
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