1031 Exchange Rules in California

Last reviewed: June 2026. State rules change. Verify current forms before closing.

What Is Different in California

California is the most compliance-heavy state in the country for a 1031 exchange. It hits you at both ends. The state withholds money at closing unless you claim an exemption on Form 593. Then it tracks your deferred gain for as long as you own out-of-state replacement property, using an annual filing called FTB 3840. Miss that filing and the Franchise Tax Board can assess tax on the entire deferred gain. The good news: a properly handled exchange can defer one of the highest state tax bills in the nation, up to 13.3% on top of federal taxes.

Does California Conform to IRC Section 1031?

Yes. California follows the federal like-kind exchange rules for real property. A 1031 exchange is an IRS-approved way to sell investment property and buy replacement property without paying tax on the gain right away. If your exchange qualifies for federal deferral, California defers its income tax too. New to exchanges? Start with our 1031 exchange guide.

One important distinction: California defers the tax. It does not forgive it. The state treats gain built up on California property as California-source income, no matter where you or your replacement property end up. More on that below.

California Tax Rate on Real Estate Gains

California taxes capital gains as ordinary income. There is no lower capital gains rate like the federal system has. The top rate is 13.3% for 2026, the highest in the country. Most investors with a large property sale land in the 9.3% to 12.3% brackets, and a big gain can push you into the top bracket in the year of sale.

That rate structure is exactly why exchanges matter so much here. On a $500,000 gain, the California bill alone can approach $66,500 at top rates. A qualifying exchange may defer all of it.

Nonresident Withholding at Closing

California requires withholding on most real estate sales, and it applies to residents and nonresidents alike. The default amount is 3 1/3% (3.33%) of the total sales price, not the gain. Sellers may instead elect an alternative withholding amount based on the actual gain at maximum tax rates. Sales of $100,000 or less are exempt.

On a $1,000,000 sale, the escrow holder withholds $33,300 unless you certify an exemption. That is real money sitting with the state instead of working in your exchange.

How 1031 Exchangers Claim the Exemption: Form 593

The exemption happens on Form 593, the Real Estate Withholding Statement. You certify the transfer is part of a deferred or simultaneous like-kind exchange. Get the form to the escrow person or your qualified intermediary before closing. A qualified intermediary is the independent party that holds your sale proceeds during an exchange. WealthBuilder 1031 prepares exchange documentation that supports the Form 593 certification.

Two situations still trigger withholding inside an exchange:

• Boot over $1,500. Boot is any cash or non-like-kind value you receive in the exchange. If you take more than $1,500 in boot, the QI must withhold on it.
• Failed exchanges. If the exchange does not complete within the deadlines, the QI must withhold before releasing funds. California puts penalty exposure directly on the QI: the greater of $500 or 10% of the required withholding. This is one reason QI selection matters in California.

Withholding is not an extra tax. It is a prepayment that gets credited on your California return. But avoiding it at closing keeps your full equity in the exchange, which matters when you need every dollar for the replacement property and its debt replacement requirements.

The Claw-Back: FTB 3840 Annual Reporting

This is the rule that surprises the most investors. If you exchange California property for replacement property outside California, the deferred gain remains California-source income forever. The state does not lose its claim because you bought in Texas or Florida.

The tracking mechanism is Form FTB 3840, California Like-Kind Exchanges. You file it in the year of the exchange and every year after, for as long as you hold the out-of-state replacement property. The requirement applies even if you no longer live in California and file no other California return.

If you stop filing, the FTB may estimate your income and assess tax on the full deferred gain, plus penalties and interest. The filing itself is simple. Forgetting it is expensive. Put it on your annual tax calendar, and make sure your CPA knows the exchange history when you change preparers.

If you keep exchanging from property to property, the gain stays deferred. The California tax comes due only when you finally sell in a taxable transaction, or it can be eliminated for your heirs through the step-up in basis at death. Talk to your estate planning attorney about that strategy.

Federal Taxes Still Apply

A California exchange defers two layers: federal and state. Here is what a taxable sale looks like without an exchange, using round numbers.

Example: $1,000,000 sale of a California rental. Original purchase $600,000, with $100,000 of depreciation taken, so the adjusted basis is $500,000 and the total gain is $500,000.

Figures are illustrative and rounded. Your rates depend on income, filing status, and basis. A qualifying 1031 exchange may defer the entire amount. Run your own numbers with our 1031 exchange calculators, then confirm them with your tax advisor.

Risks and Things That Go Wrong in California Exchanges

• Missed FTB 3840 filings. The most common long-tail mistake. The FTB can assess tax on the full deferred gain.
• Boot surprises. Cash taken at closing, debt not replaced, or non-qualifying property received can create recognized gain, trigger withholding, and reduce deferral.
• Failed deadlines. The federal 45-day identification and 180-day completion rules apply in California with no state extensions. See the IRS rules for 1031 exchanges.
• Withholding on the wrong base. Sellers sometimes let escrow withhold 3.33% of the full price when a Form 593 exemption or gain-based election applied. Recovering it means waiting for a refund.
• Deferral is not elimination. California will tax the deferred gain when you eventually cash out. Plan the exit, not just the exchange.

California 1031 Exchange FAQs

Do I pay California tax when my exchange is fully deferred?
No tax is due at closing on a fully deferred exchange, and Form 593 can exempt you from withholding. The tax is deferred, not erased. If your replacement property is outside California, you must file FTB 3840 every year.

What is Form 593?
California's Real Estate Withholding Statement. It is how a seller certifies an exemption from the 3.33% withholding, including the like-kind exchange exemption. It must reach escrow or your QI before closing.

What happens if my exchange fails after the sale closes?
Your qualified intermediary must withhold California tax before releasing the funds to you. You would also recognize the gain federally. The QI faces penalties for getting this wrong, which is why experienced California QI handling matters.

Can I exchange California property for property in another state?
Yes. Any U.S. investment real estate can qualify. But the deferred California gain stays California-source, and FTB 3840 reporting follows you until you sell in a taxable transaction.

What is boot, and why does $1,500 matter?
Boot is cash or other non-like-kind value you receive in an exchange. Boot is generally taxable, and in California, boot over $1,500 also triggers withholding by the QI.

Sources

• California Franchise Tax Board, 2026 Form 593 Instructions
• California FTB, Reporting Like-Kind Exchanges (FTB 3840 guidance)
• Cal. Rev. & Tax Code Section 18662
• Tax Foundation, State Individual Income Tax Rates and Brackets, 2026

Want to learn more? Our 1031 exchange guide covers the full process from sale to replacement. Ready to start a California exchange? WealthBuilder 1031 is attorney-owned, serves all 50 states, and charges a flat $1,000 fee. Start at WealthBuilder1031.com or call 888-508-1901.

This page does not constitute legal or tax advice. Consult your attorney and tax advisor about your specific situation.

Ready to start your California 1031 exchange? WealthBuilder 1031 acts as your qualified intermediary for a flat $1,000 fee, $750 at your sale and $250 at your purchase. See our California 1031 exchange services to get started.