California 1031 Exchange Rules: Deadlines, Form 3840, and Withholding

A California 1031 exchange follows the federal like-kind exchange rules under Internal Revenue Code Section 1031, which the state adopts through Revenue and Taxation Code Section 18031, but California adds two features that reshape the math and the paperwork: all capital gains are taxed as ordinary income, and any exchange of California property for out-of-state replacement property triggers a lifetime annual filing obligation on Form FTB 3840 until the deferred gain is finally recognized.¹²

How California Conforms to Federal Section 1031

Revenue and Taxation Code Section 18031 incorporates the federal rules on property dispositions, including Section 1031.¹ As of January 1, 2025, California conforms to the current version of the IRC, so the post-2017 limitation restricting like-kind exchanges to real property applies at the state level too.² Equipment, vehicles, and other personal property no longer qualify.

What makes California deferral valuable is the state’s rate structure. Unlike the federal system, California does not offer a preferential rate for capital gains.³ All gains are taxed as ordinary income at marginal rates reaching 12.3%, with a 1% surcharge on taxable income over $1 million that pushes the top effective rate to 13.3%.⁴ On a seven-figure gain, that treatment can mean six figures of state tax that a successful exchange defers.

What Property Qualifies

Both the property you sell and the property you buy must be real property held for productive use in a business or for investment.⁵ Real property qualifies as like-kind regardless of its specific type. You can exchange an apartment building for a warehouse, a strip mall for raw land, or a rental house for an office building, as long as both sides serve a business or investment purpose.

Several categories are excluded. Real estate held primarily for sale, like a house bought to flip, counts as inventory rather than investment property.⁵ Your primary residence does not qualify. Neither does a vacation home used personally. If you cannot document investment intent, the Franchise Tax Board can deny the deferral and assess the full gain at ordinary income rates.

The Same Taxpayer Rule

The entity that sells the relinquished property must be the same entity that buys the replacement. The IRS identifies the taxpayer by Tax ID number, not by the name on the deed. An individual filing under a Social Security number cannot sell investment property and then have a newly formed partnership acquire the replacement under a different EIN. The exchange fails.

Single-member LLCs offer a workaround because the IRS treats them as disregarded entities. A disregarded single-member LLC uses the same Tax ID as its sole owner, so property held in that LLC is still treated as owned by the individual. In California, a community property state, a husband and wife who are the sole members of an LLC may also qualify for disregarded entity treatment under IRS guidance.

Problems appear when investors sell individually and then try to buy through a multi-member LLC or a newly created partnership. That new entity carries its own Tax ID and reads as a different taxpayer. Settle entity structure before listing the relinquished property, not after.

The 45-Day and 180-Day Deadlines

Two rigid deadlines control every deferred exchange, and both begin the day the relinquished property closes. You have 45 calendar days to identify potential replacement properties in writing, and 180 calendar days to close on the replacement.⁵ The signed identification notice must reach your qualified intermediary or another designated party before midnight on day 45. Whether weekend and holiday extensions apply under IRC Section 7503 is unresolved, and most qualified intermediaries treat both deadlines as absolute.

The 180-day window has one catch: if your tax return is due before day 180, the exchange period ends on the return due date instead. Filing an extension pushes that return date out, so most exchangers file one as a precaution.

Identification Rules

You must identify replacement properties using one of three methods:

Three-property rule: name up to three properties regardless of combined value. Most investors use this method.
200% rule: identify any number of properties as long as their total fair market value does not exceed twice the value of the property sold.
95% rule: identify any number of properties at any total value, but you must actually acquire at least 95% of the aggregate identified value. It leaves almost no room for a deal to fall through.

Identify four or more properties above the 200% threshold and you fall into the 95% rule by default, whether you intended that or not.

Boot: What Happens in a Partial Exchange

When an exchange is not perfectly balanced, the leftover value is called boot, and it triggers taxable gain. Boot takes several forms: cash left over after acquiring the replacement, debt relief when the new mortgage is smaller than the old one, or personal property received as part of the deal.⁵

Recognized gain is limited to the amount of boot you receive and can never exceed your total realized gain. Sell a property with $300,000 in realized gain, take $50,000 in cash boot, and you recognize $50,000. You cannot recognize a loss on boot in a like-kind exchange; the loss is deferred entirely.⁵

Avoid boot by buying replacement property that costs at least as much as the property sold and carrying equal or greater debt on the new asset. Trading down in price or in debt creates boot. California’s ordinary-income treatment of capital gains means boot here produces a larger state tax bill than the same boot would elsewhere.

California Withholding and Form 593 at Closing

California imposes mandatory 3⅓% withholding on most real estate sales, collected through Form 593 at closing.⁶ A properly structured 1031 exchange can avoid withholding, but only if the seller certifies the exemption on Form 593 before escrow closes.⁷ Miss the certification and the escrow company or qualified intermediary must withhold, pulling cash out of your exchange proceeds that can be difficult to recover in time.

Two situations still trigger withholding even with the exemption. Boot exceeding $1,500 is subject to withholding on that amount.⁷ And if the exchange ultimately fails or does not qualify for nonrecognition, the intermediary must withhold 3⅓% of the total sales price, even when the failure was unintentional, such as missing the 45-day identification deadline.⁶

Form FTB 3840: California’s Annual Reporting Rule

This is the rule that distinguishes California 1031 exchanges from exchanges almost anywhere else. Exchange California real property for replacement property located outside the state and defer any portion of the gain, and you must file Form FTB 3840 with your state tax return for the year of the exchange and every year afterward until the deferred gain is finally recognized.² A later exchange of the out-of-state replacement into yet another out-of-state property does not end the obligation; the California-sourced deferred gain stays on the books.⁸

The form reports the original California property, the replacement property’s location, and the total deferred gain. Skip the filing and the FTB can estimate your income and assess the full tax on the deferred gain, plus penalties and interest.⁸ Failing to file can accelerate the very tax you were trying to defer.

Non-Residents Must Still File

The Form 3840 obligation applies regardless of where you live.⁸ An out-of-state investor who owned California rental property and exchanged into Texas property still owes California an annual filing. If you are not otherwise required to file a California return, you submit Form 3840 as a standalone filing. The form covers individuals, estates, trusts, partnerships, LLCs, and corporations. For disregarded entities like single-member LLCs, the owner files, not the entity.

Filing Deadlines by Entity Type

For 2026 calendar-year filers:

Individuals, estates, and trusts: April 15, 2026 (October 15 with extension).
S corporations and LLCs taxed as S corporations: March 16, 2026 (September 15 with extension).
C corporations and LLCs taxed as C corporations: April 15, 2026 (November 16 with extension).
Partnerships and LLCs taxed as partnerships: March 16, 2026 (October 15 with extension).

The Qualified Intermediary Requirement

You cannot touch the sale proceeds during the exchange. Actual or constructive receipt of the funds at any point between sale and purchase fails the exchange and makes the entire gain immediately taxable. A qualified intermediary holds the proceeds in a segregated account and uses them to acquire the replacement property on your behalf.⁹

Federal regulations define who cannot serve as your intermediary. Anyone who has been your employee, attorney, accountant, investment banker, broker, or real estate agent within the two years before the exchange is treated as your agent and is disqualified.⁹ Two narrow exceptions apply: someone whose only prior work for you involved other 1031 exchanges, and companies that provided routine title insurance, escrow, or trust services.

California does not license qualified intermediaries, so due diligence falls on you. Ask about errors and omissions insurance and whether exchange funds sit in separately identified accounts rather than commingled ones. An intermediary that goes bankrupt or mishandles funds while holding your proceeds can turn a deferral into a total loss of equity.

If You Need to Buy Before You Sell

Finding the right replacement property before selling your existing one calls for a reverse exchange, in which an exchange accommodation titleholder parks the replacement property under IRS Revenue Procedure 2000-37 while you arrange the sale. The same 45-day and 180-day deadlines apply, but the entire parking arrangement must wrap up within 180 days.¹⁰ Fees run higher because the accommodation titleholder takes title, arranges financing, and manages the property during the parking period. California’s Form 3840 obligation still applies if the replacement property ends up outside the state.

1
California Legislative Information. California Code Revenue and Taxation Code 18031 – Gain or Loss on Disposition of Property
2
State of California Franchise Tax Board. Reporting Like-Kind Exchanges
3
Franchise Tax Board. Capital Gains and Losses
4
Franchise Tax Board. 2025 California Tax Rate Schedules
5
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
6
Franchise Tax Board. FTB Publication 1016 Real Estate Withholding Guidelines
7
Franchise Tax Board. 2025 Instructions for Form 593 Real Estate Withholding Statement
8
Franchise Tax Board. 2025 Instructions for Form FTB 3840 California Like-Kind Exchanges
9
eCFR. 26 CFR 1.1031(k)-1 – Treatment of Deferred Exchanges
10
Internal Revenue Service. Revenue Procedure 2000-37