A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
The Combined Rate accounts for Federal, State, and Local tax rate on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which results in a tax rate increase of 1.18 percent). The Combined Rate does not account for New Mexico permitting of a 50% State deduction of Federally taxable capital gains.
New Mexico levies state taxes at rates ranging from 1.70% to 4.90%, assessed over progressive income brackets.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
In New Mexico, a community property state, most property acquired during a marriage is automatically considered community property, meaning it’s equally owned by both spouses. This includes assets like:
• Real estate
• Wages
• Income from investments or businesses
However, there are exceptions. Separate property, such as assets owned before the marriage or those acquired as a gift or inheritance, remains the sole property of the individual spouse. Understanding the distinction between community and separate property is critical when dealing with any property transaction, particularly a 1031 exchange, to ensure legal and tax compliance.
In a 1031 exchange, the IRS has strict rules: the same taxpayer who sells the relinquished property must acquire the replacement property for the transaction to qualify for tax deferral. In New Mexico, if the property is classified as community property, both spouses must typically consent to the transaction, even if only one is listed on the title. Their participation helps avoid disputes and ensures adherence to both IRS regulations and state laws. Failing to involve both spouses could jeopardize the exchange’s compliance and lead to complications.
Disregarded Entities
If a property is held in a disregarded entity, such as a single-member LLC, the IRS treats the property as owned by the individual member for tax purposes. However, in a community property state like New Mexico, both spouses may need to be involved in the transaction if the property is community property. This ensures compliance with IRS guidelines and maintains the integrity of the 1031 exchange.
Do Divorces effect 1031 Exchanges?
In the event of a divorce, New Mexico courts divide community property equally. This division can impact the ability to perform a 1031 exchange if the property is subject to division. Transfers of property between spouses or former spouses related to the cessation of marriage are generally not subject to tax under IRC Section 1041, but this does not apply to 1031 exchanges. Careful structuring is required to ensure tax deferral. If one spouse wishes to retain the property post-divorce, they may need to buy out the other's interest, and this transaction must be structured to maintain eligibility for a 1031 exchange.
Community property laws in New Mexico require careful consideration in 1031 exchanges. Proper planning and thorough documentation are essential to maintaining compliance with state and federal laws, avoiding disputes, and achieving a successful tax-deferred sale. If you’re dealing with community property or a potential divorce scenario, working closely with knowledgeable professionals like Deferred.com can make all the difference.
6,894+ Exchanges (and counting...) — Deferred is redefining how 1031 exchanges should be. Our experienced team delivers a service level that exceeds expectations, with no fee—while earning you interest on your exchange funds.
