Section 1031 allows investors to suspend capital gains tax implications on the sale of a property. Transactions for a 1031 exchange are eligible when reinvesting the earnings into a like-kind property. Instead of paying taxes on the sale of the property, this exchange defers the amount until the sale of a replacement property.
Often used in real estate transactions, this technique allows investors to expand their portfolios without immediate tax costs. The primary goal of a 1031 exchange is to encourage business activity by allowing taxpayers to defer tax implications. Investors must use the profits to acquire a similar property type, known as like-kind property.
Can I Exchange Property Across State Lines?
While it’s possible to conduct a 1031 exchange across state lines in the United States, there are state-level regulations and tax implications to understand.
- Federal law – you can sell a property in one state and purchase a like-kind property in another state. Doing this can still potentially delay capital gains implications.
- State taxes and regulations – while federal law permits out-of-state property exchanges, state-level tax laws may vary. Some states may enforce their own taxes on property capital gains, and may have rules or clawback provisions.
- Clawback provisions – some states have already implemented clawback provisions, which allow them to collect taxes on 1031 exchanges as soon as the replacement property is sold.
- Reporting requirements – other states may have specific reporting requirements, such as withholding taxes on sales by non-residents.
When considering a 1031 exchange that crosses state lines, it’s essential to conduct due diligence with professionals who are familiar with state laws and regulations. Working with a title insurance agency like Cortes and Hay enables you to understand the potential tax implications associated with cross-state 1031 exchanges.
Do International Properties Qualify for 1031 Exchanges?
International properties do not qualify for 1031 exchanges under current U.S. tax law. To qualify for a 1031 exchange, both properties must be located within the United States borders, as per IRS regulations. This rule was further clarified with the Tax Cuts and Jobs Act of 2017, which limited 1031 exchanges strictly to real property held for investment or business purposes within U.S. borders.
Exchanging a locally-based investment property for one located abroad will not qualify for the tax deferral of a 1031 exchange.
The IRS does not consider foreign and domestic real estate to be like-kind due to the variances in laws, regulations, and property rights across borders. Investors who wish to diversify internationally should explore additional tax planning strategies, such as utilizing foreign tax credits, structuring ownership through entities, or considering alternative deferral options.
While 1031 exchanges remain a powerful tool for building wealth through domestic real estate investment, they are not a solution for those moving capital between U.S. and international markets.
Eligibility Requirements for Out-of-State 1031 Exchanges
Although you can exchange property in one state for a similar property in another state, there are prerequisites to follow.
- Like-kind property – it’s imperative for both properties to be for investment or business use. No personal use, such as a primary residence, is eligible for out-of-state 1031 exchanges. Properties should be similar in nature to be considered like-kind, although not necessarily of the same quality.
- Time constraints – the identification of the replacement property has a 45-day time limit after the sale of the relinquished property. The full exchange has a completion time limit of 180 days.
- Qualified intermediary – an experienced practitioner, such as Cortes and Hay, ensures the correct handling of funds and compliance with regulations.
- U.S properties only – the properties involved in the exchange must both fall within U.S borders. While the IRS permits foreign property exchanges, they must be swapped with other international properties.
- No personal use – properties held for personal use, such as a primary residence or vacation home, are not eligible for 1031 exchanges. Vacation rentals may be permitted if they are held for investment, with limited personal use.
What is FIRPTA
The Foreign Investment in Real Property Tax Act (FIRPTA) imposes U.S. tax obligations on foreign individuals selling U.S. real estate. If the seller is foreign, the buyer must withhold up to 15% of the sale price for IRS prepayment. This withholding applies even if the seller ultimately owes less tax or none at all. If the buyer fails to withhold, they can be held liable for the amount due.
FIRPTA also affects foreign buyers indirectly, as they may face increased reporting requirements when purchasing from a foreign seller. There are exceptions, such as when the buyer intends to use the property as a residence and the sale price is under a certain threshold. Buyers and sellers must determine foreign status early and consult a tax professional to ensure compliance.
How We Can Help
Out-of-state properties are eligible for a 1031 exchange. The relinquished and replacement properties must be in the U.S. and meet the IRS like-kind criteria. A 1031 exchange enables investors to diversify across markets without triggering immediate capital gains taxes on property sales.
However, rules around timing, identification, and proper use of qualified intermediaries are strict. Working with experienced tax and legal professionals, such as Cortes and Hay, ensures compliance and maximizes your investment potential. For more information on 1031 exchanges, contact us.