Discussion:Arizona 1031 exchange

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Discussion Forum Index --> Tax Questions --> Arizona 1031 exchange


LAddington (talk|edits) said:

13 March 2007
I have a client that had rental property in AZ which they did an out-of-state 1031 exchange (the new property is located outside of AZ). Does AZ recognize the 1031 exchange, or will they have to pay capital gains for AZ in the year of the exchange? Or is there simply a reporting requirement for AZ, where they will only have to pay gains there when they sell the new property? Any help is appreciated. I couldn't get much help off of the AZ Dept. of Revenue website. LAddington 09:31, 13 March 2007 (CST)

WillyB (talk|edits) said:

19 March 2007
Contact the AZ dept of revenue and ask.

Or see if they have their tax statutes online and search them.

LAddington (talk|edits) said:

21 March 2007
Thanks for the reply. I called the AZ Dept of Revenue and they said if it wasn't taxable for Federal, it wouldn't be taxable for AZ. Makes me cautious though as they always have the disclaimer that you can't rely on information that their representatives give you over the phone. The website is not much help. I appreciate your reply though!

WillyB (talk|edits) said:

21 March 2007
You are welcome. Know what you mean about the disclaimers like you mentioned. Does

not instill alot of confidence.

You might find some actual legal authority in the AZ code or regulations, if you can sort through it.

Try:


http://www.revenue.state.az.us/ResearchStats/Researchmainmenu.asp

or

http://www.azleg.state.az.us/ArizonaRevisedStatutes.asp?Title=43

Good luck.

KatieJ (talk|edits) said:

21 March 2007
Ariz. Rev. Stats. Sec. 43-1001(1) defines "Arizona adjusted gross income" as federal AGI, subject to the specific modifications provided in Secs. 43-1021 and 42-1022. There is no statutory modification for gains deferred into property acquired under an IRC Sec. 1031 exchange. Therefore, no gain will be recognized on the exchange.

If your clients are Arizona residents when they sell the out-of-state property, all of the gain recognized at that time will be subject to Arizona tax. If they are nonresidents at that time, the only provision that would suggest taxation of the gain to the extent it was deferred at the time of the exchange is the general rule that income from real or tangible personal property located in the state is Arizona source income (Ariz. Adm. Code Sec. R15-2C-601(c)).

The language of the California regulation (18 Cal. Code of Regs. Sec. 17951-3) is virtually identical to the Arizona regulation. The California FTB has taken the position that the gain deferred on the exchange of California property for out-of-state property is California source income to a nonresident when it is recognized when the out-of-state property is sold. FTB Pub. 1100, 4-1-2005, p. 12-13. This is just an administrative position taken by the FTB, and as far as I can see it has not been challenged in a published ruling or decision. It wouldn't be too surprising, though, if Arizona were to take California's position if the issue were to come up.

Kevinh5 (talk|edits) said:

21 March 2007
Discussion:1031 Basis Out of state - Different state

Riley2 (talk|edits) said:

22 March 2007
KatieJ, I believe that Arizona issued a ruling that has the effect of what you are describing. See Case No. 200500205-I, Arizona Department of Revenue, CCH ΒΆ 400-821.

KatieJ (talk|edits) said:

22 March 2007
Thanks for the cite, Riley. That ruling involves taxpayers who were Washington residents (no income tax in WA) at the time they exchanged Washington property for property located in Arizona. They subsequently became Arizona residents, and then sold the property acquired in the exchange. They argued that they had paid a transfer tax to Washington at the time of the exchange and therefore their basis should be increased for Arizona purposes by the deferred gain. Arizona DOR said all the gain that was recognized for federal purposes was taxable in Arizona. There was no credit for the transfer tax paid to Washington, because it was not an income tax.

The ruling doesn't address the issue of the source of the deferred gain, because it involves the taxation of a resident, rather than a nonresident. It denies any credit for the tax paid to Washington because it was not an income tax. It doesn't say whether Arizona would have allowed the credit if Washington had imposed an income tax on the deferred gain on a source basis, i.e., whether Arizona would have considered the deferred gain to be Washington source income.

So I don't think the ruling really answers the question. It does somewhat reinforce my "hunch" that Arizona would consider the deferred gain on Arizona property to be Arizona source income to a nonresident, however.

The real problem with that position, though, from the states' perspective, is how the state where the exchanged property was located is going to know when the out-of-state property is sold by a nonresident -- perhaps many years later. Unless the taxpayer has some other reason to file a return in the state where the original property was located in the year of the sale, that state will never hear about it unless the taxpayer just happens to march in and volunteer. That's why some states do not allow deferral of gain into out-of-state property, but tax the gain in the year of the exchange.

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