What is the California Clawback rule for 1031 Exchangers?

Many Exchangers are unaware that a California provision requires them, after exchanging a Relinquished Property in the Golden State and acquiring a Replacement Property outside of California to report the status of that Replacement Property annually to the Franchise Tax Board.

Pursuant to the California Revenue and Taxation Code, investors involved in a 1031 exchange transaction who sell California property and purchase non-California Replacement Property will be required to file an annual information return with the California Franchise Tax Board (FTB), reporting this non-California property. And, these reporting requirements apply to all 1031 exchanges of property which occurs after January 1, 2014.

The California taxes that were previously deferred will be due and payable when and if the taxpayers sell their new properties and elect to take their profits rather than continuing to defer taxes through additional 1031 exchanges. Also, if taxpayers fail to file the annual return on form 3840, the FTB may estimate taxes due and assess tax, interest and penalties.

So, if you've exchanged out of California and acquired replacement Property in another state, get familiar with Franchise Tax Board Form 3840.