California 1031 Exchange Guide

Section 1031 generally applies to real property held for productive use in a trade or business or for investment.

Depending on the circumstances, qualifying real estate may include:

• Rental properties


• Apartment buildings


• Commercial properties


• Industrial real estate


• Office properties


• Retail properties


• Land held for investment


• Other qualifying business or investment real estate

Property held primarily for sale generally does not qualify, and a personal residence used solely as a home typically does not fall within Section 1031.

Investors with mixed-use, vacation, or previously owner-occupied property should discuss their circumstances with a qualified tax professional.

California investors generally follow the same federal timing requirements that apply to deferred 1031 exchanges elsewhere in the United States.

45-Day Identification Period

Potential replacement property generally must be identified within 45 days after the transfer of the relinquished property.

180-Day Exchange Period

The replacement property generally must be received within 180 days after the transfer of the relinquished property, subject to the applicable federal income tax return deadline.

These periods run concurrently, which means the 180-day period does not begin after the 45-day identification period ends.

Yes, qualifying California investment real estate can potentially be exchanged for qualifying real property located elsewhere in the United States.

Federal like-kind rules generally do not require the relinquished and replacement properties to be in the same state. U.S. real property, however, is not considered like-kind to real property located outside the United States.

This flexibility can be valuable for California property owners who want to evaluate opportunities in different markets.

However, moving the replacement property outside California creates an important additional state reporting consideration.

California continues to track certain deferred gains when California real estate is exchanged for property outside the state.

If an investor exchanges one or more California properties for one or more properties located outside California and any portion of the California-source realized gain or loss remains unrecognized, the investor generally must file Form FTB 3840, California Like-Kind Exchanges.

The form generally must be filed:

• For the taxable year in which the exchange occurs


• For each subsequent taxable year while the California-source gain or loss remains deferred

The filing obligation can continue even if the out-of-state replacement property is later exchanged again through another qualifying 1031 exchange. California states that the reporting obligation continues until the California-source deferred gain or loss is ultimately recognized.

This is one of the most important differences for California investors considering replacement property in another state.

Investors should not assume that exchanging California property for real estate in another state eliminates California's interest in the deferred gain.

California's FTB 3840 reporting system is specifically designed to track California-source gain that remains deferred after an exchange into out-of-state property.

The eventual tax treatment depends on the investor's circumstances and what happens with the replacement property.

Because residency, property location, subsequent exchanges, and eventual disposition can affect the analysis, investors considering an out-of-state exchange should involve a California tax professional early in the process.

California also has real estate withholding requirements that can apply when California real property is sold or transferred.

A properly structured simultaneous or deferred Section 1031 exchange can qualify for an exemption from withholding on the qualifying exchange amount. California Form 593 includes a certification specifically for transfers intended to qualify as Section 1031 exchanges.

However, withholding issues may arise if:

• The investor receives taxable cash or other non-like-kind property


• The exchange fails


• The transaction does not ultimately qualify for Section 1031 treatment

The California Franchise Tax Board states that when a deferred exchange is certified on Form 593, a Qualified Intermediary may have withholding obligations if taxable boot exceeds $1,500 or if the exchange fails or does not qualify.

Investors should coordinate the withholding paperwork with their Qualified Intermediary, escrow professionals, and tax advisor before closing.

Selling California investment real estate can provide an opportunity to reconsider where and how you want to own property.

Your next investment might involve another California property, real estate in another state, multiple replacement investments, or certain professionally managed real estate structures.

That flexibility can be especially relevant for property owners who want to:

• Diversify beyond a single market


• Explore different property types


• Reduce active property management


• Reposition into markets with different investment characteristics


• Consider professionally managed real estate


• Adjust their strategy as financial or retirement priorities change

The right replacement property strategy should reflect your objectives rather than assuming your next investment must resemble the property you sold.

For some accredited investors, a Delaware Statutory Trust may be another replacement property strategy to evaluate.

Under the circumstances described in IRS Revenue Ruling 2004-86, beneficial interests in a properly structured DST may be treated as interests in the underlying real property for federal tax purposes, allowing certain DST interests to potentially qualify as replacement property in a Section 1031 exchange.

DSTs can provide access to professionally managed real estate but also involve important considerations including liquidity, fees, financing, sponsor risk, property performance, and limited investor control.