Relocating for Work: Sell Your Rental and Exchange Into Something You Can Own From Anywhere

The decision is whether you want to stay a landlord from a distance

A relocation forces a question many owners put off: who will handle the leaks, the turnovers and the rent increases when you live a flight away. You have three paths: keep the property and hire a manager, sell and pay the tax, or exchange into something that fits your new life. The remote landlord guide compares keeping the property with an outside manager.

Federal law is indifferent to the move. Section 1031 asks only that both properties be held for investment or business use, and subsection (h) treats US and foreign real property as not like-kind, so a rental in one state can be exchanged for property in any other state.

What a move does change is timing, state tax and, sometimes, whether the property is a rental at all.

Schedule the sale around the move, because the exchange clock runs from the closing date

The 45-day identification period and the 180-day exchange period both start when the old property transfers, not when you arrive in the new city. Section 1031(a)(3) also ends the exchange period at the due date of your return, with extensions, if that comes before day 180, so a sale in late autumn needs an extension of the return to keep all 180 days, as explained here.

Closing during the first weeks of a new job means identifying replacement property while you are also finding a place to live. Sellers in that position often list before the move and close after it, or line up a passive replacement in advance so the 45-day list is not a scramble.

Reg. section 1.1031(k)-1(c)(4) lets you identify up to three properties of any value, or more if their total value stays within 200% of what you sold. A list that mixes a property near your new home with a DST interest as a backstop uses that rule well.

The state you leave can withhold at closing and keep taxing the deferred gain

The state where the property sits may tax the gain even after you leave, and some states collect at the closing table. California is the clearest example. The Form 593 instructions require withholding of 3 1/3% of the sales price on a taxable sale, exempt a deferred like-kind exchange at the initial transfer, and require withholding if you receive more than $1,500 of cash or other non-like-kind property.

California also follows the gain after the exchange. The FTB 3840 instructions require anyone who exchanges California real property for property outside California to file Form FTB 3840 for the year of the exchange and every later year until the deferred California gain is recognized, whether or not the person still lives there. The source of the gain is fixed when it is realized.

Check the closing-table rule for your state in states that withhold at closing, and whether the deferred gain stays taxable there in state capital gains and the 1031.

Hypothetical: a $900,000 California duplex sold the month you start a job in another state

Hypothetical: you bought a duplex years ago, have an adjusted basis of $400,000 and sell it for $900,000, a $500,000 gain, a few weeks after your move. Run your own numbers with your CPA, because depreciation, selling costs and your new state's rules change the result.

• Taxable sale: escrow withholds $30,000, 3 1/3% of the price, as a prepayment toward your California return, and the full $500,000 gain is reported federally and to California as California-source income.
• Exchange into replacement property in your new state or into DST interests: no California withholding at the initial transfer, no federal or California tax now, and a Form FTB 3840 filed every year.
• Partial exchange taking $60,000 of cash: that boot is taxable federally and in California, and because it exceeds $1,500, withholding applies.
• Years later, a taxable sale of the replacement: California taxes the original $500,000 of California-source gain at that point, even if you no longer live there.

If the rental was your home until the move, section 121 may beat an exchange

Many relocating owners are selling the house they lived in, not a long-held rental. Section 121 excludes up to $250,000 of gain, or $500,000 on a joint return, for a home owned and used as a principal residence for two of the last five years. If a job move forces a sale before two years, section 121(c) allows a reduced exclusion.

Reg. section 1.121-3(c) treats the sale as caused by a change in place of employment if the new job is at least 50 miles farther from the home than the old job was. A home you rent out after moving can sometimes use both the exclusion and an exchange; section 121 or 1031 for a former home works through those combinations.

For a true rental, the hands-off replacement matters most. A DST interest is managed by its trustee and sponsor, and Rev. Rul. 2004-86 is built on investors having no operating role, which is the point for an owner who will not be nearby. A net-leased building puts most operating costs on the tenant but still leaves you with the lease, the tenant's credit and the next vacancy; DST vs net lease compares them.