Executing a 1031 Exchange goes beyond learning the federal rules. U.S. states usually add their own layer of regulations that add complexity to the exchange. For investors, understanding these state-specific rules is crucial for a successful exchange.
If you’re planning an exchange that involves Texas properties, you may have wondered about the location’s distinct regulations and how they compare to those of other states. Realized 1031 shares what you need to know about Texas 1031 Exchange rules to address this concern. We’ll also compare the provisions of other states for a clearer comparison. Let’s take a closer look.
Are There 1031 Exchange Compliance Texas Rules?
Texas doesn’t have income tax. By extension, the state doesn’t levy capital gains taxes for any real estate transaction. This means that there are no additional 1031 Exchange rules at the state level. Once you’re done fulfilling IRS requirements, then you’re done. There are no supplemental procedures or filings you’ll need to fill out or submit.
Texas vs Other States 1031 Exchange
In other states, there are various other processes and documentation that you’ll need to accomplish as part of a like-kind exchange.
- Clawback Provisions: States like California require you to fill out forms that help track future out-of-state exchanges, so they can “clawback” the gains you deferred.
- Withholding Tax: Colorado, California, and other states impose a withholding tax from the total sales price, ensuring that they get a cut of the tax before you leave the state.
These 1031 Exchange state differences are not issues in Texas because of the lack of income tax. As such, the state has become an appealing option for many investors, especially those planning for long-term holds.
Understanding the Core 1031 Exchange Rules
While there are no state-specific 1031 Exchange rules for Texas, it adheres to the federal laws and procedures imposed by the IRS. Qualifying for tax-deferral means the exchange must comply with the following requirements.
Like-Kind Rule
You can only exchange two or more properties of similar nature or “like-kind.” More specifically, these assets must have been held for business or investment use. Apartment complexes, office buildings, and industrial properties are a few examples.
Timelines
The entire exchange must be executed within 180 days. There’s also the 45-day identification period, which begins the day after closing the sale of the relinquished property.
Qualified Intermediary
Investors cannot gain direct control of the funds to prevent constructive receipt. For this reason, a qualified intermediary (QI) is necessary to take control of the proceeds and hold them in escrow.
Reinvestment of All Proceeds
Any non-like-kind property you receive, such as leftover cash or mortgage relief, will be considered a taxable boot. As such, it’s important to match or exceed the value of the relinquished property when finding the replacement asset.
The 1031 Exchange Process in Texas
Beyond the basic requirements, Texas exchanges must follow the process set by the IRS for traditional or forward exchanges.
- Engage with the QI: Beyond holding your funds, the QI oversees the entirety of the exchange. You must engage with one even before starting the transaction.
- Sale of Relinquished Property: You have free rein regarding how you sell your current property. The most important thing is that the buyer must send the cash to the QI, not to your accounts.
- Identification Period: Select up to three properties and submit the details to the QI for official identification.
- Negotiation and Closing: Negotiate with the seller of your chosen property and close the sale. Once your QI transfers the proceeds to the seller, the exchange is complete. Since we’re in Texas, the only documentation you’ll need to file are those for federal-level tax reporting.
Why Exchange in Texas?
The benefits of exchanging in Texas aren’t just limited to the lack of income tax. The state has local governments with transparent tax laws and procedures, helping simplify filing for other related liabilities like property taxes. Plus, the state has shown steady economic growth over the past few years across many markets. For those who are planning long-term holds, Texas offers stability and a permanent shield against state-level capital gains taxes.
Wrapping Up: Like-Kind Exchange Regulations Texas
Compared to other states, Texas doesn’t have specific rules for 1031 Exchanges due to the fact that there’s no income tax. For investors, this reality opens up various advantages, such as simpler transactions and more equity left for acquiring new assets. As long as you follow the federal IRS requirements and process, you should be able to move your capital to Texas without the added complications.
Sources:
https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx
https://calawyers.org/real-property-law/what-is-a-1031-exchange/
