California 1031 Exchanges: Plan the Tax Structure and Financing Together

A qualifying 1031 exchange can defer recognition of gain when business or investment real estate is exchanged for qualifying like-kind real estate. Financing approval and tax qualification are separate decisions. Arrange both before the sale of the property you are giving up.

ECHL's role is mortgage financing and coordination. Your tax adviser, legal counsel and exchange intermediary should determine the exchange structure, documentation and tax consequences. A mortgage broker's loan discussion does not establish that a transaction qualifies for deferral.

Begin with the property and its use

Federal Section 1031 generally applies to real property held for investment or use in a trade or business. It does not generally cover equipment or vehicles. Property held primarily for sale is excluded. A personal residence does not qualify simply because its value increased. United States real property is not like-kind to foreign real property.

Like-kind does not require identical buildings. Different forms of qualifying real estate may qualify, but mixed personal use, related parties and ownership changes need specific professional review. Give the advisers the actual use history and ownership documents before selecting replacement property. The IRS real-estate exchange overview describes the basic scope.

Put the two deadlines on the financing calendar

In a standard deferred exchange, replacement property generally must be identified within 45 days after the relinquished property is transferred. Receipt of replacement property must occur by the earlier of 180 days after that transfer or the due date of the federal return for the transfer year, including extensions. These are deadlines rather than minimum waiting periods.

Identification must meet written identification rules. Agree with the intermediary on who receives it and how delivery is documented. Multiple-property identification has additional rules, so do not assume that an unlimited shopping list qualifies. A delayed appraisal or unfinished loan file does not automatically extend the exchange periods. Check the Form 8824 instructions with the tax adviser.

Protect the exchange structure before proceeds move

A standard qualified-intermediary arrangement uses a written exchange agreement and appropriate assignments with restrictions on your access to funds. Receiving or controlling sale proceeds can defeat the intended treatment. Sending money to an intermediary after receiving it does not automatically repair the problem.

A simultaneous exchange, a delayed exchange and an arrangement involving acquisition before sale have different execution needs. Reverse and improvement exchanges require specialized structuring. Tell the advisers early if you intend to buy first or complete construction as part of the exchange; an ordinary purchase followed by a later sale is not automatically a reverse exchange.

Borrowing and deferral must be reconciled

Cash received, non-like-kind property or certain debt-relief situations can create recognized gain, often discussed as “boot.” Deferral also affects the replacement property's tax basis. Have the tax adviser reconcile sale proceeds, debt paid off, replacement financing and cash contributed. A lender's maximum loan amount is not a tax calculation.

For the financing review, prepare the replacement property's intended use, leases or rent evidence where relevant, purchase contract, ownership structure and available reserves. Confirm how exchange funds reach settlement and which lender conditions must be satisfied. Keep a backup financing plan within the approved exchange structure rather than assuming a deadline will make an underwriter waive a requirement.

California can continue tracking deferred gain

California generally conforms to the Internal Revenue Code as of January 1, 2025 subject to state rules. For taxable years beginning on or after that date, its like-kind exchange treatment is limited to real property.

When California property is exchanged for property outside California and California-source gain or loss remains deferred, Form FTB 3840 is generally required for the exchange year and annually until that deferred amount is recognized. A filing can be required even without another California return obligation. A further exchange does not automatically end the tracking. Use the FTB reporting guidance to plan the state filings with your adviser.

Bring financing into the discussion early

Consider an invented investor selling a rental house to acquire a different rental property. Before the first closing, the investor's adviser confirms the proposed tax structure while the intermediary prepares exchange documents. Douglas reviews possible financing for the replacement property's actual use and loan amount. Each professional has a defined decision to make before funds move.

Contact ECHL with the proposed property type and exchange timeline to discuss available financing. Keep tax returns, exchange agreements and account details in the designated secure document channel.