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California Legislative Bill Would Repeal IRC Section 1031 and Other Tax-Free Exchange Provisions in California

Loeb & Loeb LLP - Los Angeles Office

April 13, 2010

Previously published on April 2010

As an apparent attempt to increase tax revenue California, A.B. 2640, introduced on February 19, 2010, would repeal IRC Section 1031 and several other tax-free exchange provisions of the Internal Revenue Code for California income tax purposes. Section 1031 is widely used by taxpayers, principally to engage in tax-free exchanges of business or investment real estate for other like-kind real property. Over time, the IRS has made Section 1031 a user friendly provision by allowing deferred exchanges where funds are held by a neutral third party while the exchanging taxpayer looks for replacement property.

Other sections of the Internal Revenue Code that would be repealed for California income tax purposes include: i) Section 1032 which permits a corporation to issue its stock for money or property without paying income tax on the proceeds; ii) Section 1033 which permits the tax-free replacement of property that has been condemned or involuntarily converted to cash as the result of a casualty; iii) Section 1035 which allows for the tax-free exchange of certain insurance policies; iv) Section 1041 which permits spouses to transfer property to each other incident to a divorce without recognizing taxable gain; and v) Section 1042 which allows sales of certain companies to an employee stock ownership plan (“ESOP”) without recognizing gain for tax purposes if the proceeds of the sale are invested in certain types of qualifying investments.

In the present form of the bill, these repeals would be effective starting with the current 2010 tax year. The provision repealing Section 1042 also changes the rules for tax years between 1998 and 2010 by making the tax free rollover provision inapplicable to sales of S corporations. The repeal of these provisions by California would cause a serious lack of conformity between Federal and California tax law and act as an impediment to many types of transactions. The bill has been referred to the Committee on Revenue and Taxation and a hearing on the bill has been scheduled for May 3. We will keep you posted on further developments.


The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

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