A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
In New York, when a nonresident sells real property, they must estimate their personal income tax liability on any gain from the sale. The estimated tax rate is based on the highest tax rate for the taxable year. Here are the key points regarding the withholding rules:
For more detailed information, you can refer to the New York State Department of Taxation and Finance website.
The Combined Rate accounts for Federal, State, and Local tax rate on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which results in a tax rate increase of 1.18 percent).
New York has "tax benefit recapture," by which many high-income taxpayers pay their top tax rate on all income, not just on amounts above the benefit threshold.
New York state recognizes 1031 exchanges, and with one of the highest tax rates in the nation, they can be incredibly beneficial for real estate investors. New York can also be considered aggressive when it comes to auditing 1031 exchange transactions, and there are some local nuances to completing an exchange.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
New York State has taken an aggressive approach to auditing like-kind exchanges and applying federal guidance and case law to those audits. The Department of Taxation frequently scrutinizes closing statements and other financial records to uncover inconsistencies and unreported income, particularly in reverse and build-to-suit exchanges.
While there is no specific clawback for 1031 exchanges in tax statutes, New York’s claw-back practice has been observed in audits. In the case where a 1031 exchange is completed, and a loan is taken to access tax-free funds while avoiding capital gains taxes, excess loan proceeds are treated as boot and taxable. New York has audited refinances before and after 1031 exchanges, often using Schedule L from Forms 1120S and 1065 to identify non-compliant transactions.
In New York, reverse exchanges do not trigger the Real Estate Transfer Tax (RETT) because the replacement property is initially acquired by an Exchange Accommodation Titleholder (EAT) and later transferred to the taxpayer. Since the taxpayer funds the EAT and only receives the deed after selling the relinquished property, they are not considered to have purchased the replacement property directly, thus avoiding the RETT.
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