California takes the position that when real property located in California is exchanged in an IRC Section 1031 like-kind exchange for property located outside California, the gain realized from the California property that is deferred under Section 1031 remains Californiasource gain when the second property is subsequently sold. For example, assume the taxpayer lives in Florida but owned an apartment building in California. The taxpayer exchanged the California apartment for an apartment building in Florida. Gain was realized but not recognized for income tax purposes due to Section 1031. The taxpayer then sold the apartment building in Florida three years later. Upon the sale of the Florida building for any amount equal to or greater than he received on the earlier sale of the California property, the taxpayer would owe tax to California on the amount of gain that was deferred when the California property was exchanged for the Florida property.
It was common that taxpayers either forgot that they owed tax to California or simply ignored their obligation to pay California tax. The Franchise Tax Board did not have any effective means of keeping track of the ownership of real property located outside California. To address this problem, in June the legislature added Section 18032 to the Revenue and Taxation Code. Beginning on January 1, 2014, each taxpayer who has exchanged California real property for real property outside California will have to file an annual report with the Franchise Tax Board on a form to be prescribed. This annual reporting obligation applies to both residents and nonresidents of California. The statute authorizes the Franchise Tax Board to determine what information will be required to be provided but presumably it will include confirmation that the taxpayer still owns the out-of-state property.
If a taxpayer neglects to file the form, the Franchise Tax Board can assess income tax on the original disposition of the California real property. This same provision was also added to the corporate franchise tax statutes in Section 24953 of the Revenue and Taxation Code.