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1031 Exchange for California Sellers, Explained Plainly · Connor with Honor: AI, Real Estate and Real Life

• 0:00
  SPEAKER_00: Today I want to talk about 1031 Exchanges.
• 0:02
  SPEAKER_00: I'm a real estate agent.
• 0:04
  SPEAKER_00: I'm not a tax attorney, not a CPA, but I have some information that might help you wrap your mind around this process with dates, deadlines, time frames, the different types, and all that fancy stuff.
• 0:14
  SPEAKER_00: I'm Connor McIver.
• 0:16
  SPEAKER_00: Have a look.
• 0:16
  SPEAKER_00: We'll be with you in the next one, and thank you so much for watching.
• 0:20
  SPEAKER_00: 1031 Exchange has hard deadlines and strict rules, and one wrong move blows the whole thing and triggers the full tax bill.
• 0:27
  SPEAKER_00: So use this to understand the machine.
• 0:30
  SPEAKER_00: Then hire the right people, a qualified intermediary, your own CPA, tax attorney, just to run it.
• 0:37
  SPEAKER_00: Now let me lay out the way I would at the kitchen table do this.
• 0:41
  SPEAKER_00: A 1031 exchange gets its name from section 1031 of the Internal Revenue Code.
• 0:48
  SPEAKER_00: And here's the plain idea.
• 0:49
  SPEAKER_00: When you sell an investment or business property at a gain, you normally owe capital gains and depreciation recapture that same year.
• 0:58
  SPEAKER_00: A 1031 exchange lets you roll the entire proceeds into another investment property and defer all of that tax.
• 1:05
  SPEAKER_00: Notice the word deferred, not erased.
• 1:09
  SPEAKER_00: You're not dodging the tax.
• 1:10
  SPEAKER_00: You're kicking it down the road a little bit like a good game of kick the can.
• 1:14
  SPEAKER_00: Sometimes for decades, sometimes forever.
• 1:16
  SPEAKER_00: And if you play the long game right, and I'll get to that.
• 1:20
  SPEAKER_00: Now the first thing you have to be clear on is what qualifies, because this trips people up immediately.
• 1:25
  SPEAKER_00: A 1031 is only for real property held for investment or for use in a business.
• 1:32
  SPEAKER_00: It's not for your primary residence.
• 1:34
  SPEAKER_00: Your house that you live in uses Section 121 exclusion instead.
• 1:40
  SPEAKER_00: This is a different tool.
• 1:41
  SPEAKER_00: A rental house, an apartment building, a commercial building, raw land held for investment, a warehouse, all of that qualifies.
• 1:49
  SPEAKER_00: And since the tax law changed in 2017, only real property qualifies anymore.
• 1:54
  SPEAKER_00: Personal property, such as equipment, vehicles, artwork, none of that works in a 1031 today.
• 2:02
  SPEAKER_00: It is real estate for real estate.
• 2:04
  SPEAKER_00: So the good news is like the like-kind rule for real estate is very broad.
• 2:08
  SPEAKER_00: Like kind does not mean you have to swap a rental house for another rental house.
• 2:14
  SPEAKER_00: Any real property held for investment in the United States is considered like kind to any other real property held for investment in the United States.
• 2:23
  SPEAKER_00: So you can sell a Santa Clarita rental condo and buy raw land in Texas, or sell a duplex and buy a share of a commercial building, or sell an apartment building and buy a strip of a strip mall of retail businesses.
• 2:38
  SPEAKER_00: It just has to be investment or business real estate for investment or business real estate.
• 2:44
  SPEAKER_00: And it has to be domestic United States property for domestic United States property.
• 2:50
  SPEAKER_00: You cannot exchange a California rental for a property in Mexico and then defer it.
• 2:55
  SPEAKER_00: Now here's the rule that makes or breaks most exchanges, and it's about who is allowed to touch the money.
• 3:02
  SPEAKER_00: You, the seller, can never take possession of sale proceeds.
• 3:06
  SPEAKER_00: Not one day, not in your account, not through your own escrow at your discretion or direction.
• 3:13
  SPEAKER_00: The moment you have what the IRS calls actual or constructive receipt of the money, the exchange is dead and the whole gain is taxable.
• 3:22
  SPEAKER_00: So the law requires a qualified intermediary, sometimes called an accommodator or an exchange facilitator.
• 3:30
  SPEAKER_00: This is an independent third party that you hire or get referred to by some on your realtor, and you have to hire them and have the agreement in place before the sale closes, not after.
• 3:42
  SPEAKER_00: The qualified intermediary steps into your sale, receives the proceeds directly from escrow, holds the money, and then uses that money to buy your replacement property on your behalf.
• 3:55
  SPEAKER_00: You direct the process, but you never handle the cash.
• 4:00
  SPEAKER_00: If you close your sale and the check comes to you first, it is over.
• 4:04
  SPEAKER_00: This is not a step that you need to improvise or even want to try to.
• 4:08
  SPEAKER_00: You line up the qualified intermediary early before the relinquished property closes.
• 4:14
  SPEAKER_00: Now the deadlines.
• 4:15
  SPEAKER_00: And these are two numbers that keep exchanges up at night.
• 4:19
  SPEAKER_00: From the day your sale closes, the day you give up the old property, you have exactly 45 calendar days to identify your replacement property in writing.
• 4:30
  SPEAKER_00: And you have exactly 180 calendar days to actually close on that replacement and complete the exchange.
• 4:38
  SPEAKER_00: And here's the part people misunderstand.
• 4:40
  SPEAKER_00: Those two clocks start on the same day and they run at the same time.
• 4:47
  SPEAKER_00: The 45 days is not separate from the 180 days.
• 4:51
  SPEAKER_00: The 45 days is inside the 180.
• 4:55
  SPEAKER_00: So on day one, you have both clocks running.
• 4:57
  SPEAKER_00: On day 45, your list of targets is locked, and by day 180, you must have closed.
• 5:05
  SPEAKER_00: There's one more wrinkle to this.
• 5:07
  SPEAKER_00: The exchange must be done by the earlier of 180 days or the due date of your tax return for that year.
• 5:17
  SPEAKER_00: So a sale late in the year can force you to file an extension to protect the full 180 days.
• 5:25
  SPEAKER_00: These deadlines are close to absolute.
• 5:28
  SPEAKER_00: There are no casual extensions.
• 5:30
  SPEAKER_00: Weekends and holidays count.
• 5:32
  SPEAKER_00: The only relief is when the IRS grants extensions for federally declared disasters.
• 5:39
  SPEAKER_00: And you don't want to be counting on a wildfire declaration to save your exchange.
• 5:44
  SPEAKER_00: Miss the 45 days and you're done.
• 5:46
  SPEAKER_00: Miss the 180 and you are done.
• 5:50
  SPEAKER_00: Put a thermometer in me, I'm done.
• 5:52
  SPEAKER_00: Put it on the calendar in ink.
• 5:55
  SPEAKER_00: Now the identification rules.
• 5:57
  SPEAKER_00: Because you do not just get to wave at the whole market on day 45, your written identification has to follow one of three rules.
• 6:06
  SPEAKER_00: The first is the three property rule.
• 6:09
  SPEAKER_00: You can identify up to three replacement properties, any value, no limit, and you can end up buying one, two, or all three.
• 6:17
  SPEAKER_00: Most exchanges use this one.
• 6:19
  SPEAKER_00: The second is the 200% rule.
• 6:22
  SPEAKER_00: You can identify more than three properties, as many as you want, but the total fair market value of everything you identify cannot exceed 200%.
• 6:33
  SPEAKER_00: That's twice the value of the property you sold.
• 6:36
  SPEAKER_00: The third is the 95% rule, which is the escape hatch if you break the first two.
• 6:41
  SPEAKER_00: And it says if you identify more than three, then they total more than 200%, you must actually acquire at least 95% of the total value you identified, which is hard.
• 6:55
  SPEAKER_00: So most people never rely on it.
• 6:57
  SPEAKER_00: The identification has to be in writing, signed and delivered to your qualified intermediary or another party to the exchange by midnight of day 45.
• 7:07
  SPEAKER_00: Now let me get to the money math because this is the number one place sellers lose part of the benefit without you actually meaning to.
• 7:14
  SPEAKER_00: To defer 100% of your tax, you have to do three things on the replacement side.
• 7:18
  SPEAKER_00: Number one, you have to buy a property of equal or greater value than the one you're selling.
• 7:24
  SPEAKER_00: Number two, you have to reinvest all of your net equity, all of the cash that came out of the sale.
• 7:30
  SPEAKER_00: Number three, you have to replace the debt you had.
• 7:33
  SPEAKER_00: Meaning if you had paid off a$400,000 loan when you sold, you need to take on at least$400,000 in new debt on the replacement, or bring in that much new cash.
• 7:45
  SPEAKER_00: If you buy something cheaper or you pull cash out, or you take on less debt, the difference is called boot, and boot is taxable.
• 7:58
  SPEAKER_00: Cash you keep is cash boot.
• 8:01
  SPEAKER_00: Debt you shed and do not replace is mortgage boot.
• 8:05
  SPEAKER_00: You can still do a partial exchange and defer most of the gain while paying tax on just the boot.
• 8:12
  SPEAKER_00: And sometimes that's exactly the right call.
• 8:15
  SPEAKER_00: But you should decide that on purpose with your CPA, not discover it by accident at closing.
• 8:21
  SPEAKER_00: Now let me walk through the two ends because you asked for the seller's view on both ends, and in an exchange, you're wearing two hats.
• 8:29
  SPEAKER_00: On the first end, the downlaid, you're the seller of your old property, the relinquished property.
• 8:35
  SPEAKER_00: Your job on this end is to set the exchange up before you close.
• 8:39
  SPEAKER_00: That means telling your listing agent and your escrow officer up front that this is a 1031, getting the qualified intermediary engaged in the exchange agreement signed before closing, and making sure the escrow sends the proceeds to the intermediary and not to you.
• 8:57
  SPEAKER_00: You also want a cooperation clause in your purchase contract, a simple line that says the buyer agrees to cooperate with your 1031 exchange at no cost or liability to them.
• 9:09
  SPEAKER_00: So nobody balks at the paperwork at the last minute.
• 9:12
  SPEAKER_00: The day that sale closes, your 45 and 180 day clocks begin.
• 9:18
  SPEAKER_00: So you want to already be shopping, ideally, already have candidates in mind.
• 9:23
  SPEAKER_00: Because 45 days in a tight market goes really fast.
• 9:27
  SPEAKER_00: On the second end, the up leg, you become the buyer of the replacement property.
• 9:32
  SPEAKER_00: But from the exchange point of view, you're still completing your own sale.
• 9:37
  SPEAKER_00: Just on the other side, your job on this end is to identify within 45 days to make sure whether you buy, whatever you buy, is equal or greater in value with all equity reinvested and debt replaced to have the qualified intermediary use the held funds to acquire it and to close by day 180.
• 9:59
  SPEAKER_00: The replacement has to be bought by the same taxpayer who sold.
• 10:04
  SPEAKER_00: The name on the tax identity that sold the old property has to be the name or tax entity that buys the new one.
• 10:12
  SPEAKER_00: You cannot sell as yourself and buy in your brother's name or brand new partnership and keep the deferral.
• 10:20
  SPEAKER_00: There are a few flavors of exchange worth knowing by name.
• 10:24
  SPEAKER_00: The standard one, where you sell first and then buy within the windows, is called a delayed exchange.
• 10:30
  SPEAKER_00: And it's what 90%, 90 plus percent of people actually do.
• 10:35
  SPEAKER_00: A simultaneous exchange is where both close the same day.
• 10:39
  SPEAKER_00: It's rare now.
• 10:40
  SPEAKER_00: A reverse exchange is where you buy the replacement first before you sell the old one, which you do through a special holding entity called an exchange accommodation title holder.
• 10:52
  SPEAKER_00: And it's more expensive and more complex, but it saves you when the property you want appears before your sale closes.
• 10:59
  SPEAKER_00: And an improvement or construction exchange lets you use exchange funds to build or improve the replacement property.
• 11:07
  SPEAKER_00: But all of that work and the closing has to happen inside 180 days, which is tight.
• 11:13
  SPEAKER_00: Now the California part, because this is where our state does something, most states do not, and every Santa Clarita investor in Los Angeles investor needs to hear it.
• 11:23
  SPEAKER_00: California fully recognizes the 1031 exchange and will let you defer the California tax right alongside the federal tax.
• 11:31
  SPEAKER_00: But California has what is known as the clawback provision.
• 11:35
  SPEAKER_00: Under Revenue and Taxation Code sections 18032 and 24953.
• 11:42
  SPEAKER_00: Here's what that means in plain English.
• 11:44
  SPEAKER_00: If you sell a California property and exchange it into a replacement property outside of California, California doesn't forget about the gain that you deferred.
• 11:55
  SPEAKER_00: The state taxes the position that the gain was earned on California soil.
• 12:01
  SPEAKER_00: So it belongs to California whenever you finally cash out.
• 12:04
  SPEAKER_00: Now to track this, the California makes you file a form called FTB, Form 3840 from the year of the exchange, and then every single year after that, as long as you hold that out-of-state replacement property, even if you moved out of California and stopped filing California returns for anything else.
• 12:24
  SPEAKER_00: You keep filing the 3840 every year until the day you finally sell that replacement without doing another exchange.
• 12:31
  SPEAKER_00: And on that day, California reaches back and taxes the original California source gain you deferred all those years ago.
• 12:39
  SPEAKER_00: You skip that Form 3840 filings, and the franchise tax board will eventually match the records, issue a proposed assessment, and add penalties and interest so the clawback does not stop you from exchanging out of state.
• 12:53
  SPEAKER_00: And plenty of investors do exactly that to escape California rents and rules, but you carry a California filing obligation and a California tax tail with you until you either recognize the gain or the clawback is wiped out at death.
• 13:08
  SPEAKER_00: And that brings me to the end game.
• 13:10
  SPEAKER_00: The reason the sharpest investors love this tool, you can exchange again and again and again.
• 13:17
  SPEAKER_00: Sell a rental, exchange into a bigger one, hold it, exchange into a bigger one after that, deferring the tax every single time.
• 13:26
  SPEAKER_00: The old line for it is swapped till you drop.
• 13:30
  SPEAKER_00: Because when you die still holding the property, your heirs get a stepped-up basis.
• 13:35
  SPEAKER_00: The property resets to its fair market value on the date of death, and every dollar of deferred gain across every one of those exchanges.
• 13:43
  SPEAKER_00: Federal and California both disappear.
• 13:46
  SPEAKER_00: The tax you kept kicking down the road never gets paid by anyone.
• 13:50
  SPEAKER_00: That's how families build and hold real estate empires across generations, and it ties directly to the long game of building wealth that outlives you.
• 13:59
  SPEAKER_00: Now let me give you the quick buyer's perspective since you ask, because sooner or later you will be on the other side of the table from an exchanger, or you'll be the one buying the exchanger's old property.
• 14:10
  SPEAKER_00: If you're buying a property from a seller who's doing a 1031, understand that seller is on the clock and that clock is leveraged.
• 14:17
  SPEAKER_00: You should respect on both sides.
• 14:18
  SPEAKER_00: First, expect a cooperation clause in the contract asking you to accommodate their exchange.
• 14:25
  SPEAKER_00: And it is standard.
• 14:26
  SPEAKER_00: It costs you nothing.
• 14:27
  SPEAKER_00: You are just acknowledging their intermediary will be involved.
• 14:31
  SPEAKER_00: So don't let it scare you.
• 14:33
  SPEAKER_00: Second, know that a 1031 seller often cannot afford to let the deal die because a collapse can wreck their exchange and hand them a tax bill, which can make them motivated on price and terms if you're a reliable buyer who can close on time.
• 14:49
  SPEAKER_00: Number three, if you are a seller on the replacement side selling to an exchanger who is up against day one, 170 of their window, understand that deadline driven and a buyer is racing a hard federal deadline, is a buyer with less room to walk.
• 15:06
  SPEAKER_00: So price and terms can move your way.
• 15:09
  SPEAKER_00: But do not agree to a closing date you cannot actually hit.
• 15:13
  SPEAKER_00: Because if you make them miss their window and you've created a very unhappy party and possibly a lawsuit.
• 15:18
  SPEAKER_00: And fourth, if you're using yourself and the buyer, if you yourself are the buyer and you are also thinking about becoming an investor, watch how the exchanger structures the deal.
• 15:31
  SPEAKER_00: Because the day you own investment property, this same tool is waiting for you.
• 15:35
  SPEAKER_00: So there it is.
• 15:36
  SPEAKER_00: The whole 1031 exchange machine from seller side, both ends, defers capital gains, a depreciation, recapture when you roll investment real estate into more investment real estate.
• 15:47
  SPEAKER_00: It requires a qualified intermediary hired before you close, and you can never touch the money.
• 15:53
  SPEAKER_00: 45 days to identify in writing.
• 15:56
  SPEAKER_00: 180 days to close, both clocks start at the day your sale closes and running together.
• 16:02
  SPEAKER_00: Identify under the three property rule, the 200% rule or the 95% rule.
• 16:09
  SPEAKER_00: By equal or greater, reinvest all of your equity, replace your debt, or the shortfall is taxable boot.
• 16:18
  SPEAKER_00: The same taxpayer who sells must buy.
• 16:20
  SPEAKER_00: California honors the exchange, but claws back its share with an annual form$3840 if you go out of state.
• 16:28
  SPEAKER_00: And hold it until death, and the whole deferred tax steps up and vanishes for your heirs.
• 16:34
  SPEAKER_00: Line up your qualified intermediary and your CPA before you list, not after, because the day you close without a plan, the door is shut.
• 16:43
  SPEAKER_00: Run your exact numbers with your own tax professional.
• 16:46
  SPEAKER_00: That's a complete picture.
• 16:48
  SPEAKER_00: Plain and straight.
• 16:49
  SPEAKER_00: SantaClaritaOpenhouses.com.
• 16:51
  SPEAKER_00: I'm Connor, and we'll see you in the next one.