Does a 1031 exchange defer transfer tax or property tax reassessment?

Section 1031 reaches only the income tax on your gain

Section 1031(a) says no gain or loss is recognized on a qualifying exchange. Recognition is an income tax concept, so the statute governs your federal return and, through conformity, most state income tax returns.

Transfer taxes and property taxes are not taxes on recognized gain. They are levied by states, counties and cities under their own statutes, each with its own base and its own list of exemptions, and none of those lists treats a federal exchange as a reason to skip the tax.

The income tax side of the state question is covered in does a 1031 defer state capital gains tax. This page covers the two costs that sit outside it.

Transfer taxes are charged on each deed, so both legs of an exchange can be taxed

A transfer tax measures the deed or the price. California's county documentary transfer tax under Revenue and Taxation Code section 11911 is 55 cents for each $500 of value conveyed. Florida's documentary stamp tax under section 201.02 is 70 cents on each $100 of consideration.

Your sale is a conveyance, and so is your purchase. Whoever pays the tax on each deed by law or contract pays it in an exchange too; the federal treatment of the gain does not enter the calculation.

Where a state does address exchanges, the relief is narrow. Washington's rule, WAC 458-61A-213, taxes an exchange facilitator's acquisition and exempts its later transfer to you only if tax was paid on the first transfer, a supplemental statement is filed and your funds paid for the property. Your own sale is taxed normally. State-by-state detail is in the closing guides, for example Washington's REET and Florida's doc stamps.

A replacement purchase can reset the assessed value, starting with California

Under article XIII A of the California Constitution, the general levy may not exceed 1% of full cash value, which is the appraised value when property is purchased or changes ownership, and that base may rise by no more than 2% a year. Revenue and Taxation Code section 60 defines a change in ownership as a transfer of a present interest, including beneficial use, substantially equal in value to the fee.

The Board of Equalization states that once the assessor finds a change in ownership, the property must be reassessed to current fair market value as of that date. Your replacement purchase is a change in ownership like any other, so it starts with a new base year value at its price, whatever basis you carry for income tax.

Florida takes a different route to a similar result. Section 193.1555 caps annual increases on nonresidential property at 10% for levies other than school taxes, then assesses at just value as of the January 1 after a change of ownership or control.

Worked example: a California trade-up adds tax on both sides

Hypothetical, round numbers, county tax only; run your own numbers with your CPA. You sell a rental for $1,000,000 that has been assessed at about $400,000 for years, and buy a $1,500,000 replacement in another California county.

The county documentary transfer tax on the sale is 55 cents per $500, or $1,100. On the purchase it is $1,650, payable by whoever bears it under the contract. City taxes, where they apply, are much larger and are covered in California city transfer taxes.

The new property's assessed value starts at $1,500,000, so the 1% general levy is about $15,000 a year against about $4,000 on the old one, before voter-approved bonds and assessments. The exchange still defers the income tax on your gain.

• Sale deed: about $1,100 county transfer tax.
• Purchase deed: about $1,650 county transfer tax.
• General levy: from about $4,000 to about $15,000 a year.
• Federal and California income tax on the gain: deferred.

Budget the costs, then decide what they change

Transfer taxes on the sale are a closing cost, and most can be paid from the proceeds without creating boot; see closing costs paid from exchange funds. A higher property tax bill on the replacement is an operating cost that lowers its net income, so it belongs in the comparison of candidate properties.

A Delaware Statutory Trust interest is a beneficial interest in a trust that already holds title, so no deed is recorded in your name. That does not make state taxes disappear: Florida's statute counts transfers of beneficial title and of control of entities, and the trust's property is assessed in the trust's hands.