1031 Exchange Rules in Arizona

A like-kind exchange is a tax-deferred transaction that allows for the disposal of an asset and the acquisition of another similar asset without generating a capital gains tax liability from the sale of the first asset.

Property types that are considered to be “Like-Kind” properties and are eligible for 1031 Exchange in Arizona are:

Any Arizona real estate held for productive use in a trade or business or for investment purposes is considered like-kind. It should be noted, a primary residence does not fall into this category, however, vacation homes or rental properties may qualify if they meet qualifying criteria.

Land, land improvements resulting from human effort including buildings and machinery sited on land and various property rights over the preceding (ex. homes, apartment buildings, shopping centers, commercial buildings, factories, condominiums, leases of 30-years or more, quarries and oil fields.) All types of real property are considered like-kind and thus exchangeable for all other types of real property in a 1031 exchange.

Owners of investment and business property may qualify for a Section 1031 deferral. Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section 1031.

SIMULTAMEOUS SWAP
To accomplish a Section 1031 exchange, there must be an exchange of properties. The simplest type of Section 1031 exchange is a simultaneous swap of one property for another. In order to successfully execute a Section 1031 exchange, there must be an exchange of properties. The most fundamental form of a Section 1031 exchange is a simultaneous swap of one property for another.

DEFERRED EXCHANGES
Deferred exchanges are more complex but allow flexibility. They allow you to dispose of property and subsequently acquire one or more other like-kind replacement properties.

To qualify as a Section 1031 exchange, a deferred exchange must be distinguished from the case of a taxpayer simply selling one property and using the proceeds to purchase another property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property. Taxpayers engaging in deferred exchanges generally use exchange facilitators under exchange agreements pursuant to rules provided in the Income Tax Regulations.

REVERSE EXCHANGE
A reverse exchange is somewhat more complex than a deferred exchange. It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.

An IRC §1031 tax-deferred exchange permits property owners to defer the recognition of capital gains taxes that would ordinarily be incurred upon the sale of their business or investment properties. Taxes on capital gains are indefinitely postponed until the investor chooses to liquidate. Typically, investors are subject to state taxes only in the jurisdiction where the property is ultimately sold; however, certain states may adopt alternative stances that could potentially subject taxpayers to double taxation.

Arizona’s tax regulations include a “Clawback” provision, mandating that any appreciation in property value accrued within the state is subject to Arizona state taxes. This holds true even if the property was subsequently exchanged for one located in another state. Additionally, upon executing a “cash-out” sale, taxpayers are liable for paying taxes both in the state where the property is currently held as well as to Arizona for any gains accrued during its tenure within Arizona. This situation potentially leads to partial double taxation. Similar clawback provisions are also enforced by other states such as Massachusetts, Montana, and Oregon. These rules apply to nonresidents who swap properties within these states for replacement properties situated outside their borders.

The Arizona State Assembly has enacted legislation mandating amendments to the Arizona Revenue and Taxation Code. This legislative update introduces a requirement for investors engaging in 1031 Exchanges—who sell property located within Arizona and purchase replacement property outside the state—to submit an annual information return to the Arizona Franchise Tax Board (FTB). This report should detail the non-Arizona property acquired.

Furthermore, under the new legislation, any deferred state taxes on the original real estate investment will become payable when investors choose to sell their out-of-state replacement properties and opt to realize their gains rather than reinvesting through subsequent 1031 Exchanges.

The required information return must be submitted in the year of the transaction and annually thereafter for as long as the gain remains deferred. Non-compliance with this filing requirement enables the Franchise Tax Board (FTB) to calculate estimated taxes and impose tax liabilities, interest, and penalties accordingly. This mandate is effective for property exchanges occurring in taxable years that commence on or after January 1, 2014. While complying with Arizona’s new stipulation to submit an annual information return may seem burdensome to investors, adherence ensures exemption from Arizona taxes under the Clawback Provisions provided that they consistently employ Section 1031 for property exchanges.

1. CONSULT
Speak with your financial and tax advisors before selling your property to make sure a 1031 exchange is right for you.

2. FIND A QUALIFIED INTERMEDIARY (QI)
Choose a QI before you close escrow. They will hold your exchange proceeds during the transaction process. Do not take receipt of funds – all proceeds must go to the QI or 1031 is invalidated.

3. CHOOSE REPLACEMENT PROPERTY
You have 45 days to “identify” replacement property, and 180 days to close on the relinquished property.

Corcapa 1031 Advisors specializes in locating like-kind replacement properties at equal or greater value for full tax-deferral.

4. DEBT OR NO DEBT?
The IRS requires matching the debt from your relinquished property with equal or greater debt in the replacement property.

Don’t need debt? You can buy properties with debt or without.

Debt always brings some risk to real estate ownership, but can provide the benefit of increasing depreciable basis and sheltering some cash flow from taxation.

5. PROCESSING & PAYMENT
After you select your replacement property, Corcapa 1031 Advisors prepares your purchase documents and sends them to you for signature. Next, sign paperwork with your QI releasing your sale proceeds to the escrow account.

6. RECEIVE DISTRIBUTION
After you’ve closed on the replacement property, cash flow distributions are typically made monthly and deposited directly into your bank account.

In a like-kind exchange, it is not mandatory for the swap of properties to occur simultaneously. However, it is imperative to adhere to two specific timing restrictions. Failure to meet these deadlines will result in the entire gain being subject to taxation. These time limits are strict and cannot be extended under any circumstances or hardships, with the sole exception of those occurring during presidentially declared disasters.

The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. However, notice to your attorney, real estate agent, accountant or similar persons acting as your agent is not sufficient.

It is imperative that replacement properties are meticulously detailed in the written identification. For real estate, this specification should include a legal description, street address, or a distinct name. Adherence to IRS regulations regarding the maximum number and value of properties allowable for identification is essential.

The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.

A 1031 Exchange is a transaction in which a taxpayer is allowed to exchange one investment property for another by deferring the tax consequence of a sale. The transaction is authorized by 1031 of the IRS Code.

Contact a Corcapa 1031 Advisor for more information 1031 Exchange process and if it is right for you.