1031 Exchange State Clawback Rules
A 1031 exchange can defer federal gain, but it does not always end the old state tax story. If the property you gave up was in one state and the replacement property is outside that state, the source state may require continuing reporting and may tax the deferred source-state gain when a later taxable sale finally recognizes the gain.
California is the clearest primary-source example. California requires Form FTB 3840 when California property is exchanged for out-of-state property and any California-source realized gain or loss is not recognized. The form is generally filed for the exchange year and each later year until the California-source deferred gain or loss is recognized, even if the taxpayer otherwise has no California filing requirement (FTB reporting like-kind exchanges).
That state filing is separate from federal Form 8824. The IRS instructions say Form 8824 is used to report each exchange of business or investment real property for like-kind real property and to figure deferred gain, current recognized gain, and replacement-property basis (IRS Form 8824 instructions).
What state clawback means
A clawback rule is a source-state tracking rule. The state where the relinquished property sat is not necessarily giving up its claim just because the investor bought replacement property elsewhere. Instead, the state tracks the deferred source-state gain until a later transaction causes recognition.
For California, the continuing obligation is explicit. The FTB states that Form FTB 3840 must generally be filed for the taxable year of the exchange and each subsequent taxable year until the California-source deferred gain or loss is recognized. The same FTB page says the obligation continues even if the out-of-state replacement property is exchanged again for other property, until the California-source deferred gain or loss has been recognized (FTB reporting like-kind exchanges).
That is the practical point for any interstate exchange: do not assume the federal deferral file is complete just because the replacement property is no longer in the old state. The state file may need its own continuing schedule, basis history, and final-sale workpaper.
Federal Form 8824 is only the starting point
Federal reporting still matters first. For 2018 and later years, the IRS instructions state that section 1031 treatment applies only to exchanges of real property held for use in a trade or business or for investment, other than real property held primarily for sale. The instructions also say that if you transferred property to another party in a like-kind exchange during the current tax year, you must file Form 8824 with your tax return for that year (IRS Form 8824 instructions).
Form 8824 does not replace state tracking. It figures the federal exchange result: deferred gain, current gain if cash or non-like-kind property is involved, and basis of the property received. A state clawback schedule starts from that federal exchange history, then applies the state-source rule to the gain that was deferred.
In plain terms, Form 8824 answers: what happened federally in the exchange year? A continuing state form answers: what part of that deferred gain still belongs to the old source state, and has it now been recognized?
California FTB 3840: the clearest continuing-reporting model
California requires FTB 3840 when both conditions are present: one or more California properties are exchanged for one or more properties located outside California, and any portion of the California-source realized gain or loss is not recognized (FTB reporting like-kind exchanges).
The filing requirement is broad. FTB legislative analysis states that, for taxable years beginning on or after January 1, 2014, taxpayers deferring gain or loss under IRC section 1031 when exchanging California real property for out-of-state like-kind property must file form FTB 3840 with the FTB. It also states that the requirement applies to all individuals, estates, trusts, and business entities regardless of residency status or commercial domicile (FTB AB 1582 analysis).
California also describes the mechanics. Attach FTB 3840 to the California tax return, or file it separately as a California information return if there is no other California filing requirement. If the taxpayer does not file FTB 3840 and a tax return, the FTB says it may issue a Notice of Proposed Assessment for the previously deferred gains plus applicable penalties and interest (FTB reporting like-kind exchanges).
When the replacement property is later sold or exchanged in a taxable transaction, California tells taxpayers to remove that property from FTB 3840 in the year of sale, report the exchange or sale on the tax return, and attach a statement explaining why the property was removed. If the property is exchanged again, the taxpayer should also attach a new FTB 3840 reporting that exchange (FTB reporting like-kind exchanges).
Eventual taxable sale: how the deferred state gain comes back
The taxable sale is the point where the deferred source-state issue usually becomes real. The January 27, 2026 FTB discussion draft for proposed Regulation 17951-7 says that, when gain or loss is recognized federally on the exchange, sale, or other disposition of real property that is or has been involved in a qualifying section 1031 exchange or section 1033 conversion, the California-source amount is determined under the proposed regulation (California draft Regulation 17951-7).
For a single exchange where California relinquished property is exchanged for out-of-state replacement property, that draft text provides a lesser-of rule when the replacement property is sold or otherwise disposed of in a transaction where gain or loss is recognized federally. For gain, the California-source amount is the lesser of the deferred gain and the gain recognized for federal income tax purposes.
Hypothetical example: assume an investor deferred $80,000 of California-source gain in an interstate exchange. Years later, the replacement property is sold in a taxable transaction, and the federal recognized gain is $60,000. Under the cited lesser-of approach, the California-source gain would be $60,000, because $60,000 is less than the $80,000 deferred amount.
| Item | Amount |
|---|---|
| California-source deferred gain from original exchange | $80,000 |
| Federal recognized gain on later taxable sale | $60,000 |
| Hypothetical California-source gain under lesser-of approach | $60,000 |
The key is that the old state gain does not disappear merely because the replacement property was out of state. The final taxable sale requires a look back to the deferred gain schedule.
Oregon, Massachusetts, and Montana cautions
Do not treat California FTB 3840 as a national form template. Oregon, Massachusetts, and Montana questions require current state-specific authority, especially when the taxpayer has moved, the replacement property has been exchanged again, or another state has already taxed part of the gain.
The cited materials include one Oregon-related California ruling. In Chief Counsel Ruling 99-0571, the FTB addressed an Oregon-to-California exchange and concluded that California conformed to the federal basis rules, that the basis of the California replacement property would not be increased by gain not recognized under California law, and that the source of the deferred gain is the location of the exchanged property. The ruling also addressed a California tax credit in the year the California property was sold, unless Oregon allowed a credit (FTB Chief Counsel Ruling 99-0571).
That ruling is useful for the source-state concept, but it is not a substitute for current Oregon, Massachusetts, or Montana filing instructions. If one of those states is in the fact pattern, build a separate state checklist instead of relying only on the federal Form 8824 file.
Nonresident withholding is a separate closing issue
Withholding at sale is different from clawback reporting. California Form 593 instructions state that real estate withholding is required when California real estate is sold or transferred, unless an exception applies. The instructions list examples where withholding is not required, including a sales price of $100,000 or less and a seller or transferor certification to an exemption on Form 593, Part III (FTB Form 593 instructions).
The same instructions explain that California requires an annual information return for taxpayers who exchange California property for out-of-state like-kind property and meet the requirements of IRC section 1031. They also explain that a taxpayer must file a California tax return to claim a withholding credit, using the amount withheld from Form 593 (FTB Form 593 instructions).
The FTB legislative analysis adds two exchange-specific withholding rules. If the transferor receives boot in excess of $1,500, the qualified intermediary must withhold 3 1/3 percent (.0333) of the boot unless the alternative withholding calculation method is elected on Form 593. If the exchange fails and no other exemption applies, the qualified intermediary must withhold 3 1/3 percent (.0333) of the sales price unless the alternative calculation method is elected (FTB AB 1582 analysis).
Hypothetical example: if a California exchange fails, no exemption applies, and the sale price is $600,000, a 3 1/3 percent withholding calculation using .0333 equals $19,980. That withholding is not the final tax. It is a payment mechanism that must be reconciled on the California return.
Recordkeeping checklist
For an interstate exchange, keep the state file as carefully as the federal file:
- Federal Form 8824 for the exchange year.
- The state continuing-reporting form or workpaper, if the source state requires one.
- Settlement statements for the relinquished and replacement properties.
- A deferred gain schedule showing the source state, deferred amount, and replacement property tied to that deferred gain.
- Later sale or exchange documents showing whether the deferred gain has been recognized.
- Any withholding form, credit claim, or state notice connected to the sale.
The most common planning mistake is thinking the old state question is finished at the first replacement-property closing. For California-style reporting, the obligation continues until recognition, and a later exchange can keep the tracking file alive.
Frequently asked questions
It is a state-source tracking rule for deferred gain. California, for example, requires continuing FTB 3840 reporting when California property is exchanged for out-of-state property and California-source gain or loss is deferred. The obligation continues until that California-source deferred gain or loss is recognized.
No. Form 8824 is the federal form used to report the exchange and figure deferred gain, recognized gain, and basis. California FTB 3840 is a separate California reporting requirement for qualifying California-to-out-of-state exchanges.
California says FTB 3840 generally continues each subsequent taxable year until the California-source deferred gain or loss is recognized. The FTB also says the obligation does not cease merely because an out-of-state replacement property is exchanged again.
No. Withholding is a payment collected at closing or on a failed exchange when the withholding rules apply. The actual tax result is reconciled on the state return, while the clawback or continuing-reporting file tracks deferred source-state gain until recognition.
Review the original Form 8824, state continuing forms, deferred gain schedule, prior withholding forms, and the source state rules that applied to the relinquished property. The later sale is when deferred source-state gain may need to be reported.
Educational disclaimer
This article is for general tax education only. It is not tax, legal, accounting, or investment advice. Interstate 1031 exchanges can involve federal reporting, source-state reporting, nonresident withholding, credits for tax paid to another state, and later taxable-sale calculations. Work with a qualified tax professional before filing or structuring a transaction.
Primary sources
- FTB reporting like-kind exchanges
- California draft Regulation 17951-7
- FTB AB 1582 analysis
- FTB Form 593 instructions
- IRS Form 8824 instructions
- FTB Chief Counsel Ruling 99-0571