1031 Exchange in California
California generally conforms to federal 1031 exchange rules but has significant state-specific requirements. With state income tax rates up to 13.3%, California investors must consider both federal and state tax implications. The state requires filing Form FTB 3840 for exchanges involving California properties for out-of-state properties, and ongoing reporting until deferred gains are recognized.
Fast Facts
- State Capital Gains Rate
- Up to 13.3% (highest in nation). California taxes capital gains as ordinary income, with rates ranging from 1% to 13.3% depending on income level.
- Conforms to Federal 1031
- Yes, with exceptions. California allows personal property exchanges for individuals with AGI under $250,000 ($500,000 for joint filers).
- Additional Transfer Tax
- County documentary transfer tax of $0.55 per $500 of value (Rev. & Tax. Code section 11911). Many charter cities levy an additional city transfer tax, and some (e.g., San Francisco, Los Angeles) impose substantially higher rates on high-value transfers.
- Local Deadlines/Forms
- FTB 3840 required for out-of-state exchanges, with ongoing annual filing until deferred gain is recognized.
- Qualified Intermediary Requirements
- No state registration or licensing regime. California instead imposes financial-responsibility rules on exchange facilitators (Cal. Financial Code Division 20.5, section 51000 et seq.): a $1 million fidelity bond (or equivalent deposit/segregated funds) and errors-and-omissions coverage of at least $250,000.
- Clawback Rule
- Yes. California tracks deferred gains on out-of-state exchanges through Form FTB 3840 annual reporting requirements.
Legislative Updates
FTB 3840 Compliance Effort
The California Franchise Tax Board has run an ongoing compliance effort for Form FTB 3840, mailing letters to taxpayers identified as having a filing requirement. Under R&TC Sections 18032 and 24953, taxpayers who fail to file FTB 3840 and do not file a California return can receive a Notice of Proposed Assessment on the full deferred gain, plus penalties and interest.
AB-91: Personal Property Exchange Exception
While conforming to the federal TCJA limitation of 1031 exchanges to real property, California created an exception allowing personal property exchanges for individuals with adjusted gross income under $250,000 (or $500,000 for joint filers).
Legal and Tax Considerations
State Capital Gains Rate
Up to 13.3% (highest in nation). California taxes capital gains as ordinary income, with rates ranging from 1% to 13.3% depending on income level. The top rate of 13.3% applies to income over $1 million.
Conforms to Federal 1031
Yes, with exceptions. California generally conforms to federal 1031 exchange rules for real property, but allows personal property exchanges for individuals with AGI under $250,000 (or $500,000 for joint filers).
Additional Transfer Tax
California counties impose a documentary transfer tax of $0.55 per $500 of value (Rev. & Tax. Code section 11911). Many charter cities levy their own additional transfer tax on top of the county rate, and some (e.g., San Francisco, Los Angeles) impose substantially higher rates on high-value transfers. A 1031 exchange does not exempt a transfer from documentary transfer tax.
Local Deadlines/Forms
FTB 3840 required for out-of-state exchanges. California requires Form FTB 3840 for exchanges involving California properties for out-of-state properties, with ongoing annual filing until deferred gain is recognized.
Qualified Intermediary Requirements
California has no state registration or licensing regime for qualified intermediaries. Instead, the California Exchange Facilitators Act (Cal. Financial Code Division 20.5, section 51000 et seq.) imposes financial-responsibility rules on any facilitator that maintains an office in California, advertises facilitation services in the state, or facilitates an exchange of California property: a $1 million fidelity bond (or an equivalent cash/securities/letter-of-credit deposit, or holding funds in a qualified escrow/trust account) plus errors-and-omissions coverage of at least $250,000.
Required Documentation
- Federal Form 8824
- California Form FTB 3840 (for out-of-state exchanges)
- Complete closing statements for both properties
Clawback Rule
California tracks deferred gains on out-of-state exchanges through Form FTB 3840. Annual reporting is required until the deferred gain is recognized.
Official References
Step-by-Step Process
- 1
Identify Replacement Property
You must identify potential replacement properties within 45 days of selling your relinquished property. In California, consider property tax reassessment implications and local zoning regulations when identifying properties.
- 2
Engage a Qualified Intermediary
Work with a qualified intermediary to handle the exchange funds and documentation. Under the California Exchange Facilitators Act, facilitators doing business in California must maintain a $1 million fidelity bond (or equivalent) and at least $250,000 in errors-and-omissions coverage.
- 3
Close on Replacement Property
Complete the purchase of your replacement property within 180 days of selling your relinquished property (or by your tax return due date, including extensions, if earlier).
- 4
File Tax Returns
Report your 1031 exchange on your federal and California tax returns for the year of the exchange. California requires Form FTB 3840 for out-of-state exchanges.
- 5
File California Tax Return
Report your 1031 exchange on your California tax return (Form 540) for the year of the exchange. If exchanging California property for out-of-state property, file Form FTB 3840 annually until the deferred gain is recognized.
- 6
Property Tax Assessment
Be aware of Proposition 13 implications. California property taxes are based on the assessed value at purchase, with annual increases capped at 2%. A 1031 exchange does not carry over your old assessed value — a replacement property acquired in California is generally reassessed at its purchase price as a change of ownership.
- 7
Local Regulations
Review local zoning regulations, rent control ordinances, and development codes, which vary significantly between California municipalities.
Timeline Calculator
Enter the closing date of your relinquished property to calculate your 1031 exchange deadlines:
Common Pitfalls
Not Filing Form FTB 3840
Issue
California requires Form FTB 3840 for exchanges involving California properties for out-of-state properties, with ongoing annual filing until the deferred gain is recognized.
Prevention
Work with a tax professional familiar with California's specific 1031 exchange requirements. Set calendar reminders for annual FTB 3840 filing obligations even after moving out of state.
Overlooking Property Tax Reassessment
Issue
While a 1031 exchange defers income taxes, it doesn't prevent property tax reassessment when acquiring a new property within California under Proposition 13.
Prevention
Factor potential property tax increases into your financial projections when exchanging into California properties.
Underestimating Tenant Protection Laws
Issue
California has strong tenant protection measures, including rent control in many jurisdictions, just-cause eviction requirements, and significant relocation payment obligations.
Prevention
Research local tenant protection laws before acquiring residential rental properties. Consider commercial properties or residential properties in areas with fewer restrictions.
Misunderstanding Real Estate Withholding
Issue
California generally requires 3 1/3% (3.33%) real estate withholding on the sale of real property, but a fully qualifying like-kind exchange under IRC Section 1031 is EXEMPT from withholding at the time of the transfer. Withholding is triggered only on any non-like-kind proceeds (boot) exceeding $1,500, or if the exchange later fails to qualify for non-recognition treatment — in which case the intermediary must withhold 3 1/3% of the sales price.
Prevention
Ensure your qualified intermediary agreement is in place before closing and that the exemption is properly claimed on FTB Form 593. Plan for withholding on any boot received, and understand that a failed exchange will trigger withholding on the full sales price.
Frequently Asked Questions
Does California conform to federal 1031 exchange rules?
California generally conforms to federal 1031 exchange rules for real property. However, California continues to allow personal property exchanges for individuals with adjusted gross income under $250,000 (or $500,000 for joint filers), which differs from federal rules that limit exchanges to real property only.
What forms do I need to file for a 1031 exchange in California?
You need to file federal Form 8824 (Like-Kind Exchanges) with your federal tax return. If you’re exchanging California property for out-of-state property, you must also file California Form FTB 3840 for the year of the exchange and each subsequent year until the deferred gain is recognized.
Are there any state-specific considerations for 1031 exchanges in California?
Yes, key considerations include California’s high state income tax rates (up to 13.3%), the requirement to file Form FTB 3840 for out-of-state exchanges, property tax reassessment under Proposition 13, and strong tenant protection laws for residential rental properties.
Major Cities
Los Angeles, San Francisco, San Diego, Sacramento, San Jose
MSA Guides
References
Official References
- California Franchise Tax Board — Reporting Like-Kind Exchanges
- California FTB — Instructions for Form FTB 3840, California Like-Kind Exchanges
- California FTB — Real Estate Withholding
- California FTB — Form 593 Real Estate Withholding Instructions (1031 exemption)
- California FTB — Qualified Intermediary (withholding agent role)
- California FTB Tax News — FTB 3840 Compliance Effort (Feb 2021)
- California Financial Code Division 20.5 — Exchange Facilitators (section 51000 et seq.)
- California Department of Real Estate
- IRS — Like-Kind Exchanges Under IRC Section 1031
This information is for educational purposes only and is not legal or tax advice. Consult with qualified professionals regarding your specific situation.