1031 Exchange from California to Another State: Good Idea?

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Article Header Image: Top 3 Reasons To do a 1031 Exchange from California To Another State

Summary: For this article, I spoke with Joe Torre, one of our Investment Counselors who’s helped many of RealWealth members do 1031 exchanges from California to other states, and also my husband, a California landlord and attorney. To learn about the top 3 benefits of exchanging your California rental property for properties in other states, continue reading!

Introduction

The first thing that stood out to me when I started working for RealWealth five years ago was the company culture around creating enough passive income that you could become job optional. I remember watching a success story that our members Claudia and Julian recorded.

They did a 1031 exchange from California to another state and it paid off big time. They were able to exchange one San Francisco rental property for 20 rental properties in 3 states, all of which had property management in place. 

In doing so, they were able to increase their cash flow six times. They’re now bringing in over $15,000 in purely passive income.

Imagine having $15,000 a month in your bank account for doing absolutely nothing… it would be pretty nice, right?

If you own rental property in California that isn’t producing enough cash flow, this could potentially happen for you too. Because the truth is…  money goes so much further outside of California.

In markets like Orlando, for example, you can purchase a rental property for around $200,000 that’ll generate over $1,000 in passive income every month if you pay in cash.

If that’s not incentive enough, continue reading below to learn about the variety of other benefits to 1031 exchanging your California rental property for properties in other states.

Why Do a 1031 Exchange from California To Another State

California is hard on landlords. I know this first hand because my family owns 130 units in the Los Angeles area that they self-manage. While it makes sense for us to stay in California financially (for now!), there are a lot of hoops to jump through. So many that my husband, who is the company’s general counsel, often works every day of the week. You can imagine how happy this makes me ;).

Here are a few of the biggest difficulties of being a California landlord (which may be enough of a hindrance to make you consider exchanging your California property for properties in another state):

  1. Most properties in California are under some form of rent control
  2. It’s incredibly difficult to evict problem tenants
  3. A lot of people are leaving California, which begs question of whether the demand for rental properties will decrease in the coming years

You may also like: How To Identify 1031 Exchange Replacement Properties To Boost Cash Flow
 

Reason #1: California Has Rent Control

One of the biggest issues California landlords face is rent control. While this isn’t necessarily a deal-breaker for all California landlords, it can make life difficult for those that own 4 to 6 unit properties. These types of properties, along with single-family homes owned by LLCs, real estate trusts or corporations, are not exempt from rent control, and their size makes it difficult for them to cash flow if they can raise rents at most 5% per year (depending on the city and county). 

Owning your single-family investment property personally, rather than in an LLC, real estate trust or corporation, would solve the “rent control problem”, however doing that would create a whole new host of problems since you and your bank account would be personally liable for anything that occurs at the property. 

Reason #2: California Makes It Incredibly Hard To Evict Problem Tenants

One of the most difficult parts of having a landlord husband is having to hear about all the problem tenants who he can’t evict. Like the man who refuses to wear a mask (even though it’s mandated by the city due to COVID) in the common areas and throws his cigarette butts in the planters out front. Or the guy who lets his Golden Retriever (an Emotional Support Animal according to an internet doctor) run around the property without a leash, pooping in the hallways.

And the eviction difficulties have only gotten worse since Coronavirus began, because the state has declared an Eviction Moratorium which may make it impossible for California landlords to collect rent until December 2021. While this is understandable, because so many people are struggling right now, it’s also not fair for California to make landlords act like banks. Because that’s what banks are for!

You may also like: 8 Tips for Collecting Rent During the Coronavirus (COVID-19) Pandemic

Reason #3: People are Leaving California for More Affordable States

It’s not hard to understand why so many people are leaving California. It’s expensive here, which makes it almost impossible for the typical person to afford renting a nice apartment in a good part of town (let alone buy a home). So, people are leaving… for Austin, Cleveland and Charlotte.

And it’s likely that this trend will only continue as more and more people are working from home due to COVID. 

For those that are now only tied to a laptop instead of desktop computer in a cubicle in a San Francisco or Los Angeles office building, moving may sound really nice.

California 1031 Exchange Rules To Follow

According to Joe Torre, one of our Investment Counselors, there are no specific 1031 exchange rules to follow when you exchange from California to another state. 

Check out this article understand the general rules: 1031 Exchange Rules, Tips & Strategies for Success in Real Estate 2021

Considerations When Exchanging CA Property for Out of State Property

One thing to note when exchanging California property for another state is that California “aggressively tracks” the ultimate sale of a replacement property. When you eventually sell, they want to recoup the gains. This is true even if you no longer live in California. In order for the state to track you, they require that you complete form FTB 3840 in the year that you initiate the exchange and every year thereafter.

According to the California Franchise Tax Board, you must continue to file FTB 3840:

  • “As long as you defer the gain or loss
  • If you exchange the out-of-state replacement property with another out-of-state property as part of another exchange
  • Until you report and pay tax to California on your deferred gain or loss
  • Until the owner of the replacement property dies, eliminating the deferred California source gain or loss
  • Until you donate the replacement property to a non-profit organization”

As an investor, you need to keep this in mind if you choose to exchange California property for property in another state. A good rule of thumb is to try and never sell your replacement properties, but just continue doing 1031 exchanges and eventually leave your assets to your children or donate them to charity.

If preserving your wealth is of interest to you, you may also enjoy this article: The Ultimate Estate Planning Guide for Wealth Preservation

Need help finding cash flowing out-of-state replacement properties?

We can help! Click here to become a member of RealWealth and schedule a complimentary Replacement Property Strategy Session with one of our experienced investment counselors. Membership is 100% free and signing up takes less than 5 minutes! 😊

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