California 1031 Exchange Rules & Requirements
California is one of the most active states for 1031 exchanges, but it also has some of the strictest state-level reporting requirements in the country. While California generally conforms to federal Section 1031 tax codes, the Franchise Tax Board (FTB) aggressively tracks deferred gains, even if you leave the state.
Here are 3 critical things to know about 1031 Exchanges in California:
1. The California “Clawback” Provision
The most distinct feature of a California 1031 exchange is the state’s “Clawback” provision. If you sell a property in California and exchange it for a replacement property in a tax-free state (like Texas or Florida), California does not forgive the state taxes you owe, it simply defers them.
California takes the position that since the gain was originally accrued while the property was in California, the state is entitled to tax that gain eventually. If you later sell that out-of-state replacement property in a taxable transaction (cashing out), you will owe California state income tax on the portion of the gain that originated in California.
2. Annual Reporting Requirement: Form FTB 3840
To enforce the Clawback provision, California requires you to file Form FTB 3840 (California Like-Kind Exchanges) annually.
- Who must file: Anyone who exchanges a California relinquished property for a replacement property located outside of California.
- When to file: You must file this form for the tax year the exchange takes place and every subsequent year that you hold the out-of-state replacement property.
- If you fail to file this form, the FTB may estimate your gain and send you a tax bill for the full amount of the deferred taxes, plus penalties.
3. Mandatory Withholding & Form 593
California requires a 3.33% withholding of the total sales price on real estate sales to ensure out-of-state sellers pay their taxes. This can cause a cash-flow issue for a 1031 exchange if not handled correctly during escrow.
- The Exemption: To avoid this mandatory withholding, you must file Form 593 (Real Estate Withholding Statement) with your escrow officer before closing. You will specifically certify that the transaction is part of a Section 1031 exchange.
- The “Boot” Rule: If you receive any “boot” (cash or non-like-kind property) from the sale in excess of $1,500, the withholding requirement may kick back in on that specific amount.
- Ensure your Qualified Intermediary (QI) coordinates with the title company to submit Form 593 so that 100% of your proceeds go into the exchange account rather than to the state.
2026 1031 Exchange Trends in California
Interested in how 1031 exchanges are changing in California? Contact CapFree Xchange for specific questions about how best to proceed with 1031 exchanges in California.
Frequently Asked Questions About 1031 Exchanges in California
Does California have a specific holding period for 1031 exchanges?
California generally follows federal guidelines, which suggest a holding period of at least two years to prove “investment intent.” However, the Franchise Tax Board is known to aggressively audit “drop and swap” transactions where an entity (like a partnership) dissolves immediately before an exchange.
What happens if I exchange a California property for another California property?
If your replacement property is also in California, you follow standard federal 1031 rules. You do not need to file Form FTB 3840 annually because the property remains within the state’s jurisdiction.
What is the tax rate on “Boot” in California?
California taxes capital gains as ordinary income. Unlike the federal government, which has lower long-term capital gains rates, California will tax any non-deferred gain (boot) at your standard state income tax bracket, which can be as high as 13.3% (or more for very high earners).
Can I use a 1031 exchange to swap a vacation home in Lake Tahoe?
Only if it qualifies as an investment property. Personal residences and vacation homes used primarily for personal enjoyment do not qualify. You must pass the “usage test” (e.g., rented out for at least 14 days per year and personal use limited to 14 days or 10% of rental days) for at least two years prior to the exchange.