The California FTB (Franchise Tax Board) has gotten more aggressive challenging 1031 exchanges.
A practice that has been and is commonplace has just caused a taxpayer to have his exchange disallowed. It used to be that a partial distribution of funds held by the QI (qualified intermediary) was considered boot with resultant capital gains taxes due on the boot.
The FTB held that the ability of the taxpayer to direct the closer to distribute a portion of the proceeds from the relinquished property to her constituted ‘constructive receipt’ thereby disallowing the entire exchange. The FTB also held that the taxpayer expressly assigned all of the proceed to the qualified intermediary thereby relinquished her right to receive any of the proceeds.
If the tax payer wants to received a portion of the 1031 proceeds from the relinquished property it the must be expressly stated in the exchange agreement upfront and disclosed to the closer in order for the taxpayer to receive this amount at closing.
There’s also a second ruling in the link below that might be of interest, but I don’t think it’s not much surprise at the result in that one.