Non-Resident Withholding in a 1031 Exchange

Posted by Margo McDonnell | Fri, Jul 27, 2012

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Section 1031 tax-deferrals are allowed as part of the federal tax code. On the state income tax front, it varies from state to state. Most states follow the federal code, have a state version of 1031 or simply have no state income tax. Pennsylvania is the only state that typically does not recognize a 1031 exchange. (We can complain about that in another post!)  

Over the last ten to fifteen years, a number of states have enacted mandatory non-resident withholding taxes that must be withheld at the time of sale if the seller is not a resident of that state. There is no escaping this non-resident tax because the closing agents in these states must submit a check representing the required withholding tax to the Recorder of Deeds in order to have the deed or conveyance document recorded. In all of the states with a non-resident withholding, a taxpayer completing a 1031 exchange can request an exemption. In each state, except New Jersey, the taxpayer must file the request prior to closing. Ideally the paperwork will be filed as soon as the property is placed under contract with a buyer because it could take several weeks for the approval.  New Jersey non-resident sellers can complete the paperwork right at closing and nothing needs to done before then. Many times, as the qualified intermediary, 1031 CORP. will also have to sign the exemption request because we must withhold the required amount before releasing proceeds to you at the end of the 180-Day Exchange Period if you did not complete your exchange or traded down and did not reinvest all of your proceeds.

Note we have seen Maryland deny the request for exemption if the taxpayer has not been filing a MD tax return to report the income earned from a MD investment property.

The states that currently have a non-resident withholding requirement are as follows: California, Colorado, Delaware, Georgia, Hawaii, Maine, Maryland, Mississippi, New Jersey, New York, North Carolina, Rhode Island, South Carolina, Vermont and West Virginia. Keep in mind other states may enact laws requiring a non-resident withholding tax. 

Your Exchange Officer does always include a non-resident notice whenever sending 1031 instructions to the closing agent to make sure we can get the process started as soon as possible.

While you do have to complete paperwork, fortunately a 1031 exchange will allow you defer the state gain (except in PA) as well as avoid the non-resident withholding at the time of your closing.

Other benefits of a 1031 exchanges.

 

 

 

 

Topics: 1031 Exchange, 1031 non-resident withholding tax, NJ non-resident withholding

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