Well, I am trying to figure out what best to do. It sure looks like it is best to have a clean cut -- sell the rental in the year of move, pay the tax and be done with the California's claws. Otherwise, I could be up for double state taxation when I sell the exchanged property in future.
Tax rate for ex-Californians
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pb4uski
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If you have any loser investments in your taxable portfolio you could sell those at a loss and reinvest in similar securities (being careful not to crease a wash sale) and then sell the rental and the investment losses would help offset the gain on the rental (both while you are a Ca resident for tax purposes).
Yes, I had diligently harvested losses during the Jan-Feb swoon. But not enough to offset the anticipated CG from the rental property sale.
Bamaman
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Most people living in another state would resent having to pay California state income taxes on income derived from inside that state. But it all depends on what the retal property is worth--and what it's going to be worth in the future. If the housing market has a long way to increase, keeping property there could still be a good investment despite taxes.
If I was going to leave a state, I would want to make a clean break and not pay 10% of gross rental receipts for a real estate management company to watch after my property.
The Hill Country of Texas is welcoming Californians with open arms, and lots of job talent is moving there in droves.
pb4uski
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Why? Why would someone expect that they could in effect operate a business in another state and not have to pay state income tax to that state on the profits generated by the business? It seems naive that someone would think that they should not have to pay.
This is the info I was looking for on my CA rental I've owned for 26 years. You'd like to think you could exchange the property out of state (AZ in my case) and be done with CA. I wonder how'd they enforce the collection of this tax if the 3840 was never filed? I don't think CA has found a way to tax my stock/fund capital gains when after I move out of state.
Interesting that if I want to sell my rental, it is better to convert it to my primary residence for two years for tax purposes and just not live there but leave it vacant (it's not in the best area). The fed/state tax benefit far out weighs the after tax loss of revenue. Only depreciation would be recaptured. I'm just seeing how the math makes sense, not sure if it is fully viable.
Not wanting to pay CA taxes has become personal.
You are lucky. I think the FTB 3840 is only for properties exchanged out of CA on or after 1/1/2014.
For the unlucky folks who exchanged after this date AND did not file the 3840, the FTB will send their regards to you in your new state with a Notice of Proposed Assessment that will adjust the taxpayer’s income to recognize the previously deferred gains, plus penalties and interest.
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MasterBlaster
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The concept of primary residence and "just not live there" are mutually exclusive. If you do what you propose you should know that you are committing fraud. Considering the penalties I suggest you either live there or pay the taxes.
As I start to wade through the perpetual 1031 exchange mess with California even after I leave the state, I am thinking if it can be done in this way:
For federal taxes, I will go through a 1031 exchange to defer the capital gain taxes when I sell the rental in CA and move to GA. In addition to the regular CG tax rate, I will save on the 3.8% medicare surtax because of my income this year.
For CA state taxes, I am prepared to pay the capital gains on the year of the sale of the rental property. I am not going to try to defer the CA taxes because :
1) It is a clean cut with CA and I don't have to continue to file the FTB 3840 every year.
2) I have some CG losses to offset against part of the rental capital gains this year. It is not clear in future when I sell the rental if I can apply this CG loss.
3) If I eventually sell the rental in GA in the future, it is not clear to me if the state of CA will also want to tax me on the price appreciation that occurred on the rental property in GA. This price appreciation on the rental property in GA will then be subject to double taxation -- by CA and GA.
For federal taxes, I will go through a 1031 exchange to defer the capital gain taxes when I sell the rental in CA and move to GA. In addition to the regular CG tax rate, I will save on the 3.8% medicare surtax because of my income this year.
For CA state taxes, I am prepared to pay the capital gains on the year of the sale of the rental property. I am not going to try to defer the CA taxes because :
1) It is a clean cut with CA and I don't have to continue to file the FTB 3840 every year.
2) I have some CG losses to offset against part of the rental capital gains this year. It is not clear in future when I sell the rental if I can apply this CG loss.
3) If I eventually sell the rental in GA in the future, it is not clear to me if the state of CA will also want to tax me on the price appreciation that occurred on the rental property in GA. This price appreciation on the rental property in GA will then be subject to double taxation -- by CA and GA.
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MasterBlaster
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It's not clear to me what you are proposing is legit (ie. the split basis) . I suggest you speak with an accountant. This issue cannot be unique to you.
Probably so.
However, this appears to be the same end result if the FTB 3840 is not filed yearly. CA FTB will send you an assessment to ask you to pay the tax due to CA. Well, maybe not quite the same because there will be penalties involved in this case.
MasterBlaster
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CatotX:
Will the new state recognize a stepped up basis when the federal basis is different ?
Will the new state recognize a stepped up basis when the federal basis is different ?
Good question for me to check.
However, I think I am OK to keep the same basis for federal and GA, though theoretically it is more advantageous to me if the basis under the GA tax rules can be stepped up.
Actually on second thought, I don't think a step up basis is likely. I think CA is one of the few states that do not fully comply with the federal 1031 rules. I believe if I had been exchanging a property OUT of GA into CA, the entire CG will be deferred. GA is not going to come after me like CA does.
pb4uski
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Absent the $150k real estate gain would you be in the 15% tax bracket once you ER? If so, you may want to consider an installment sale instead of a 1031 exchange.
No matter how you do it you will owe ordinary tax on depreciation recapture, but if you sell after you quit working then at least you may be in a lower tax bracket and that will help. If you structure the transaction so the gain is recognized over a number of years in a way that keeps you in the 15% bracket then you may avoid federal CG tax entirely.
It sounds like Ca will get their piece no matter what you do so a clean break would be better IMO.
No matter how you do it you will owe ordinary tax on depreciation recapture, but if you sell after you quit working then at least you may be in a lower tax bracket and that will help. If you structure the transaction so the gain is recognized over a number of years in a way that keeps you in the 15% bracket then you may avoid federal CG tax entirely.
It sounds like Ca will get their piece no matter what you do so a clean break would be better IMO.
Once I ER, I plan to be in the 15% bracket.
I have depreciated the property over the years but I wasn't able to use it because of my income level. I believe the terminology is that I have "passive loss carryforward" and this will be entered on the Sch E in the year of sale as an expense and will offset against ordinary income.
pb4uski
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I guess my point is that if you structure the transaction right that you may be able to avoid or minimize federal income tax on your embedded gain and it sounds like Ca will get a piece no matter what you do. Given the amount involved I think you may want to consult with a CPA tax practitioner.
Not lucky, I live in CA with the rental, but reviewing my options for leaving the state in 4 years or so..
Well. we are in the same boat then, except that I am planning to leave next year. Some options mentioned in this thread to reduce the CA tax due:
a) Harvest tax losses (stock market)
b) Explore installment sale of the house
c) Move into the rental yourself. I think the rule now is that you need to live there for at least two years to get some benefit.
38Chevy454
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I think many of the points have been covered, but I will add my experience. I moved out of CA (no regrets at all, BTW) and kept my CA house as rental for 3 years. At that time I sold so I met the 2 of last 5 years primary residence rule and avoided any capital gains. I did make money on the sale vs purchase price. While out of state, I did lose money each year, so did not have the income tax problem. In fact it pissed me off when I was not able to claim the deduction on taxes and had to carry it over since total income was over the fed limit. Once sold I was able to recapture that, but it sucks not being able to take it when in the year it should apply.
I tend to agree, just get completely out of CA and make the break. If you do keep the house as rental, make sure you take a big enough equity loan out so it is cash negative for tax purposes unless you just want to keep giving income taxes to CA. You will be giving prop taxes, so it is not like CA is getting nothing. I am more than happy to have no further dealing with CA FTB.
I tend to agree, just get completely out of CA and make the break. If you do keep the house as rental, make sure you take a big enough equity loan out so it is cash negative for tax purposes unless you just want to keep giving income taxes to CA. You will be giving prop taxes, so it is not like CA is getting nothing. I am more than happy to have no further dealing with CA FTB.
also considered exchanging it into an upgraded CA home. Rent it for a year, convert it to my residence, then sell after two years to move out of state. I'm not a fan of holding real estate short term in conjunction with high transaction costs though, so not likely a plan.
I'm still trying to figure how CA can go after me if I move out of state. If I exchange a rental to an out of state property, but I still reside in CA, I understand. If I move out of CA's jurisdiction, with no property or income, I should have no responsibility to file anything in the state.
I think the article below explains it well
California Claw-Back Provision: Putting the Claw in Claw-Back | California Like Kind Exchange Reporting Requirements | Exeter 1031 Exchange Services, LLC
If you exchange out from CA to another state, and you eventually sell the property, you will be double-taxed on the portion of the capital gains that was realized when the property was sold in CA. This portion is taxable by both CA and your new state (unless your new home state is one without income taxes).
I am leaning towards making a clean cut and be rid of CA's tax claws.
Good move for you. It seems like it all worked out, even though it took a while.
pb4uski
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
If you move and then sell the following tax year, isn't your Ca tax about $11k assuming a $150k gain is your only Ca income that year? My point is that you seem to be willing to go through a lot of contortions to avoid paying $11k that they are going to get one way or another.
Oh yes, I read that three times over. But it doesn't differentiate residence in CA. What's next, I move out of CA and I still need to file when I sell my stocks & funds so I can pay cap gains tax to CA? I'd like to see a challenge to the 3840 by a non-CA resident. If I'm out of CA jurisdiction in all ways, the state should have no right to know what I do and I should have no responsibility to file anything.
Yes, if I sell the rental a year after I move out, the CA tax rate is probably a little lower. I have considered this option but decided not to pursue this because of
1) the uncertainly of housing prices (prices now at all time high, not sure what will happen in 2018).
2) I don't want to deal with the rental from 2000 miles away.
My portfolio return has been averaging 8% annualized return over the past 10 years. Rental return (if I don't consider taxes) is somewhat similar but generally with more hassles.
A part of me simply just want to be rid of rentals and put the money into the portfolio. With my portfolio, at least the end game is clear -- I will hold it forever without the need to realize capital gains, but with a rental, do I sell it sometime in the future, realize capital gains and pay taxes?
Of course the other part of me wants to investigate 1031 exchanges to defer taxes for as long as possible.
