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Tuesday, December 30, 2014

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New Filing Requirement for California Like-Kind Exchanges


California’s new filing requirement for like-kind property exchanges made under IRC Section 1031 covers like-kind exchanges that occur in tax years beginning on or after January 1, 2014.

All taxpayers who defer tax by exchanging property in California for like-kind property outside of California must now file a Form FTB 3840 annual information return for each completed exchange. It applies to all individuals, estates, trusts and business entities, regardless of their residency status or commercial domicile.

The new form provides information about the California and non-California properties involved in the exchange. It is meant to track taxpayers’ deferred gains from California properties and strengthen the enforcement of a “clawback” provision in the California tax code that applies to like-kind exchanges.  Under the clawback rules, the originally deferred gain from the sale of a California property is considered California-source income whenever the non-California replacement property is sold in a taxable transaction, no matter how many years later this occurs

Taxpayers must file Form FTB 3840 in the year the like-kind exchange is completed and each subsequent year that the related gain is deferred, even if they don’t otherwise have to file a California tax return. If a taxpayer doesn’t file Form 3840 as required, the state may estimate the income that was deferred and assess the tax and related penalties and interest, even though the taxpayer has not sold the replacement property and continues to defer federal tax.

Additional Changes Pending
For now, Form 3840 applies only to exchanges of real property. However, the California Franchise Tax Board is evaluating whether to make like-kind exchanges of tangible personal property subject to the new filing requirement in the future. For more information on how this new filing requirement could affect your tax planning in 2015 and beyond, contact David Hersch, Tax Senior Manager.

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