Commercial Real Estate Transactions and 1031 Exchanges in California

Current Landscape of Commercial Real Estate Transactions in California 

In recent years, California has seen a significant rise in commercial real estate transactions, driven by a diversified economy. In 2023, commercial real estate transactions in California totaled over $60 billion, a 15% increase from the previous year. Multifamily and industrial properties have led the market, with multifamily properties comprising approximately 40% of all transactions. This can be attributed to persistent housing shortages in the face of high demand, particularly in urban areas. A large factor contributing to the success of these properties is the pandemic and the subsequent post-pandemic recovery period, which heightened the need for stable and affordable housing. The multifamily sector continues to remain strong due to California's ongoing housing crisis, where demand is outpacing supply. With the state's population growth and urbanization trends, these properties offer promising returns and long-term value appreciation. The pandemic and post-pandemic market trends have also shown a skyrocketing growth in e-commerce, which has resulted in an immense need for distribution and fulfillment centers. As businesses adapted to these changes, investors recognized the potential of industrial properties, such as warehouses and distribution centers, which have become increasingly vital in the supply chain. As the market evolves, understanding these dynamics will be crucial for making informed investment decisions that maximize returns in California’s competitive real estate environment. 

Statistical Trends Favoring 1031 Exchanges 

With high property values and significant transaction volumes, the potential for Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s in California is immense. The state is notorious for commanding some of the highest real estate prices in the country, with the average sales price for commercial properties in California hovering at approximately $1.5 million, with urban centers like San Francisco and Los Angeles often seeing even higher prices. For example, in San Francisco, commercial properties can easily surpass the $2 million mark, driven by the city’s tech boom and limited space for expansion. Similarly, in Los Angeles, prime commercial properties in sectors such as entertainment and media are securing premium prices due to their central locations and increasing demand. 

As California’s economy continues to diversify, the demand for commercial real estate is expected to grow even further. Emerging sectors like technology, biotech, and renewable energy are driving new real estate development and acquisitions. The tech sector alone is projected to add over 200,000 jobs in the state by 2025, a surge that will undoubtedly drive greater demand for office space, research facilities, and other commercial properties. Additionally, the push for sustainability and renewable energy is driving the need for industrial spaces and manufacturing facilities. As these industries grow, investors can use Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s to transition their assets into high-growth sectors, staying ahead of market trends while deferring taxes and maximizing returns. 

Tax Liabilities Specific to California  

Utilizing a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange can help mitigate significant tax liabilities that an investor would face in the high-cost market of California. But while considering a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange , it is important to understand exactly what tax liabilities Californian transactions could be subject to, as well as recognizing the regulating bodies in charge.  

California Franchise Tax Board (FTB) 

The California Franchise Tax Board (FTB) is the taxing authority for the State of California that collects corporate and state income taxes. The FTB plays a key role in administering taxes related to commercial properties, including capital gains taxes on real estate sales. For Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s, the FTB follows federal guidelines allowing property owners to defer capital gains taxes when they reinvest proceeds into like-kind properties. However, state-specific rules may apply, such as the need to report exchanges and potentially pay deferred taxes if the Replacement Property(ies) is outside California. Compliance with both federal and state tax laws is crucial for commercial property investors using Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s. 

Deferral of State Taxes:  

While federal tax law allows for the deferral of capital gains taxes, California has its own tax implications. Investors must understand that while the federal government allows deferral, the California Franchise Tax Board (FTB) imposes additional state taxes on the gains when the property is sold and not replaced with another California property. The capital gains from the sale of the Those certain items of real and/or personal property described in the relinquished property contract and qualifying as “relinquished property” within the meaning of Treasury Regulations Section 1.1031(k)-1(a); The "Old Asset”, property or properties given up or conveyed by a taxpayer as part of a 1031 exchange. Relinquished Property will be subject to California’s state income tax rates, which can be as high as 13.3%, depending on the Seller's income bracket. High earners, especially those selling investment properties, are subject to the upper end of this tax rate. California treats capital gains as regular income, so any gain from the sale of the Those certain items of real and/or personal property described in the relinquished property contract and qualifying as “relinquished property” within the meaning of Treasury Regulations Section 1.1031(k)-1(a); The "Old Asset”, property or properties given up or conveyed by a taxpayer as part of a 1031 exchange. Relinquished Property will be taxed according to the individual's income tax bracket. For high-income individuals, California imposes an additional 1% surtax on income exceeding $1 million. This tax is known as the "Mental Health Services Act" tax and applies to capital gains from the sale of property if the Seller’s total income surpasses $1 million. Lastly, there is withholding tax on sales by nonresidents. If the property Seller is a nonresident of California, the FTB generally requires withholding 3.33% of the total sale price, or the Seller can choose to have the withholding based on the gain from the sale instead. 

California Clawback Rule: 

The California Clawback Rule refers to the state’s requirement that taxes deferred under a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange must eventually be paid on any gains that originated from a California property, even if the property has been exchanged for one located in another state. This rule is where the state of California "claws back" any deferred taxes once the Exchanger cashes out. Key points about this rule include: 

The amount received for a property, minus the property’s adjusted basis and transaction costs. Regardless of the adjusted basis of a property, there is no gain until the property is transferred. There are two types of gain: “realized gain” and “recognized gain.” Realized gain is the difference between the total consideration (cash and anything else of value) received for a piece of property and the adjusted basis. Realized gain is not taxable until it is recognized. Gain is usually, but not always, recognized in the year in which it is realized. If gain is not recognized in the year it is realized, it is said to be deferred. In an exchange under Section 1031, realized gain is recognized in part or in full to the extent that boot is received. See Boot. Where only like kind property is received, no gain is recognized at the time of the exchange. Gain from California Property: If California property is exchanged for out-of-state property, any gain realized from the California property remains subject to California state taxes. The state tracks the deferred capital gains on the California property. 

Filing a California Tax Return: California law requires that investors continue to file a California tax return each year, reporting the deferred gain on the Californian Those certain items of real and/or personal property described in the relinquished property contract and qualifying as “relinquished property” within the meaning of Treasury Regulations Section 1.1031(k)-1(a); The "Old Asset”, property or properties given up or conveyed by a taxpayer as part of a 1031 exchange. Relinquished Property , even if the Replacement Property(ies) is in another state. 

Tax Due Upon "Cashing Out": If the investor eventually sells the out-of-state Replacement Property(ies) and "cashes out" (does not do another Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange ), they will owe California taxes on the deferred gains from the original California Relinquished Property, in addition to any taxes due in the state where the Replacement Property(ies) is sold. 

Continuous Deferral: If the investor continues to do Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s, they can keep deferring both federal capital gains taxes and California state taxes, but the deferred gain from the California Relinquished Property will still be tracked by California. 

Choosing the Right Qualified Intermediary 

To successfully complete a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange , it's critical to use a knowledgeable and experienced national Qualified Intermediary (QI). Given California’s specific tax rules, including the state’s "Clawback Rule" and the importance of properly adhering to the like-kind property requirements, using a QI that understands the complexities and nuances of California’s real estate and tax landscape is essential. Failing to work with an experienced, accredited QI can lead to significant financial risks, including the loss of your tax deferral benefits. As one of the nation’s leading providers of Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange services, our experienced Accruit team and seamless processes is what investors need to ensure compliance with federal and state tax regulations.  

California’s growing commercial real estate market, paired with the potential of Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s, presents a significant opportunity for investors seeking to expand their portfolios while achieving tax deferral. By staying informed about the state’s tax implications, market trends, and the nuances of Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange s, investors can better navigate the challenges and opportunities that California offers. Whether you're investing in multifamily housing, industrial properties, or exploring emerging sectors, utilizing a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange and an experienced QI, such as Accruit, could be essential in optimizing your investment strategy and achieving long-term success in this dynamic commercial market. 

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary , and as such does not offer or sell investments or provide investment, legal, or tax advice.