California 1031 Exchange Rules: Deadlines, Forms, and Clawback

California 1031 exchange rules start with the federal statute and add two state-specific layers: a withholding exemption you claim on Form 593 at closing, and an annual Form 3840 filing that follows your deferred gain out of state for as long as it stays deferred. Get those two pieces right, and a California exchange works the same way a federal one does. Miss them, and the Franchise Tax Board can come back years later for the tax you thought you had deferred.

How California Adopts the Federal Rules

California doesn’t write its own exchange statute. Revenue and Taxation Code Section 18031 incorporates Subchapter O of the Internal Revenue Code, which includes Section 1031, for individual taxpayers.¹ Section 24941 does the same for corporations.² The federal rules on property type, deadlines, and exchange structure all apply, and California layers its own reporting and withholding on top.

What Property Qualifies

Section 1031 covers real property held for productive use in a trade or business or for investment. Both the property you sell and the property you buy have to meet that standard.³ Since the Tax Cuts and Jobs Act of 2017, personal property no longer qualifies. Only real estate.

“Like kind” is broader than most people expect. It refers to the nature of the asset, not its specific use. An apartment complex in San Diego can be exchanged for vacant land in Sacramento, or a retail building in Oakland for an industrial warehouse in Fresno. What matters is that both are real estate held for business or investment.

Two categories are excluded. Your primary residence or a purely personal vacation home doesn’t qualify because it isn’t held for investment. Property held primarily for resale, like a fix-and-flip project, is specifically excluded from 1031 treatment.³ One boundary worth flagging: U.S. real property and foreign real property are not like kind. You cannot sell a California rental and defer into a property in Mexico or Canada.

The 45-Day and 180-Day Deadlines

Two clocks start the day you close on the sale of your relinquished property. You have 45 calendar days to identify potential replacement properties in writing, and 180 calendar days to close on the acquisition.³ Both start on the same date, so the 180 days includes the 45. Miss either one and the entire deferral fails. There is no grace period.

The 180-day deadline can actually be shorter. If your tax return due date, including extensions, falls before day 180, that return due date becomes your effective deadline. Filing an extension is standard practice for exchanges that close late in the year.

You have three ways to identify replacements:

The three-property rule lets you identify up to three properties regardless of combined value. This is the most commonly used method.
The 200-percent rule lets you identify any number of properties as long as their total fair market value doesn’t exceed twice the sale price of the property you sold.
The 95-percent rule lets you identify any number of properties at any value, but you must actually acquire at least 95 percent of the total value identified. Risky and rarely used.

The Qualified Intermediary

You cannot touch the sale proceeds at any point. If the money hits your bank account, even briefly, the IRS treats you as having received the funds and the deferral fails. A Qualified Intermediary holds the proceeds from the sale and disburses them directly to the seller of your replacement property at closing.

The intermediary also prepares the exchange agreement, handles the assignment of the purchase and sale contracts, and keeps the documentation aligned with the tax-deferred structure. Fees for a standard forward exchange typically run somewhere between $600 and $1,200, with additional per-property charges if you identify multiple replacements.

California does not license Qualified Intermediaries. That means the barrier to entry is low, and vetting matters. Confirm the intermediary carries fidelity bond coverage and holds exchange funds in a segregated, FDIC-insured account. If your intermediary goes bankrupt or misappropriates the money, you lose the funds and the tax deferral.

Form 593 and Withholding at Closing

California requires withholding on real estate sales at 3⅓ percent of the sales price.⁴ On a million-dollar property, that’s $33,300 held back at closing. For a properly structured 1031 exchange, you claim an exemption on Form 593 by checking the box for a simultaneous or deferred exchange.⁵ The form has to be submitted before the close of escrow.

If the exchange later falls apart, the intermediary must go back and withhold the 3⅓ percent. An alternative calculation applies the 12.3 percent individual tax rate to the recognized gain rather than the flat 3⅓ percent to the full sales price, which can produce a smaller withholding number in some cases.⁵

The Clawback: Form 3840 and Out-of-State Replacements

This is the rule that makes California different from most other states. When you sell California real estate and buy replacement property outside California, the state doesn’t forget about the gain you deferred. The Franchise Tax Board tracks it through every subsequent exchange until you eventually sell in a taxable transaction, and then California collects its share of the original deferred gain regardless of where you live or where the final property sits.⁶

The tracking mechanism is Form FTB 3840. You file it with your California return for the year of the exchange and for every year after that until the deferred gain is finally recognized on a California return.⁷ The form asks for the adjusted basis of the property sold, the fair market value of both properties, the dates of transfer, and the amount of deferred gain.

The filing obligation does not end when you move out of California, retire, or stop earning any other California income. It continues even if you do another 1031 exchange with the out-of-state replacement property. The FTB is explicit: the filing continues “until the California source deferred gain or loss from the exchange has been recognized.”⁶

Investors who leave California and forget are the ones who get caught. Fail to file Form 3840, and the FTB can assess the original deferred tax plus interest and penalties. After a decade of non-filing, the accumulated interest alone can be substantial. The clawback doesn’t mean you pay tax twice. It means California’s share of the gain follows the investment, not the investor.

If you exchange one California property for another California property, Form 3840 is not required. The filing obligation is triggered only when capital leaves the state.

Boot and Partial Taxation

“Boot” is the term for anything you receive in an exchange that isn’t like-kind real property. Cash left over after closing, personal property added to the deal, or debt relief when the mortgage on your replacement is smaller than what you owed on the old one all count. You owe tax on the gain to the extent of the boot, even though the rest of the exchange stays deferred.⁸

California withholding intersects here. If boot exceeds $1,500, the Qualified Intermediary is required to withhold on that amount.⁵ To defer the maximum gain, reinvest all the proceeds and take on equal or greater debt on the replacement property.

The Forms, in One Place

A completed exchange generates paperwork at both levels. Missing a form won’t void the exchange, but it invites penalties and scrutiny.

Federally, you report the exchange on IRS Form 8824, attached to your federal return for the year of the exchange. The form captures the descriptions and dates of both properties, the fair market values, the adjusted basis of the property sold, and any boot received.⁹ It’s a one-time filing.

At the state level, Form 593 goes in before the close of escrow to claim your withholding exemption. Form 3840 goes in with your California return in the year of an out-of-state exchange and every year after that until the gain is recognized.

What California Is Actually Taxing

California taxes capital gains as ordinary income. The top bracket for 2025 is 12.3 percent on taxable income above $742,953 for single filers.¹⁰ Income above $1 million carries an additional 1 percent Mental Health Services Tax surcharge, bringing the effective top state rate to 13.3 percent. On top of that, federal capital gains tax runs up to 20 percent, plus the 3.8 percent net investment income tax where it applies.

On a California property with $500,000 in gain, the combined federal and state bill can easily reach $150,000 or more. Deferring that amount keeps the full equity working in the next property. Over multiple exchanges spanning decades, the compounding is where the wealth-building power of a 1031 exchange actually shows up.

When deferred gain is finally recognized, whether through a taxable sale or a failed exchange, depreciation recapture also comes due. Federally, depreciation is recaptured at up to 25 percent, separate from the standard capital gains rate. California recaptures depreciation at the same ordinary income rates. A well-structured exchange defers both layers, so the total savings on a heavily depreciated property can be larger than the capital gains number alone suggests.

The Stepped-Up Basis at Death

Here’s the fact that turns a 1031 exchange from a deferral into what can become a permanent elimination. When you die, your heirs receive the property at its fair market value on the date of death, not at your original cost basis.¹¹ All the gain you deferred through one exchange, or a chain of twenty over forty years, resets to zero.

An investor who buys a $500,000 rental, exchanges into a $1.2 million property, exchanges again into a $2.5 million property, and holds that final property until death passes a $2.5 million asset to heirs with a $2.5 million basis. The $2 million in accumulated deferred gain disappears. The heirs can sell the next day and owe nothing on that appreciation.

The planning opportunity applies to both federal and California taxes. One caveat: the California clawback filing obligation on Form 3840 continues until the gain is “recognized.” Whether the stepped-up basis at death counts as recognition for purposes of ending the Form 3840 requirement is worth resolving with a tax advisor before your heirs stop filing.

1
California Legislative Information. California Code RTC 18031 – Gain or Loss on Disposition of Property
2
California Legislative Information. California Code, Revenue and Taxation Code – RTC 24941
3
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
4
California Legislative Information. California Code, Revenue and Taxation Code – RTC 18662
5
Franchise Tax Board. 2025 Instructions for Form 593 Real Estate Withholding Statement
6
Franchise Tax Board. Reporting Like-Kind Exchanges
7
State of California Franchise Tax Board. 2025 Instructions for Form FTB 3840 California Like-Kind Exchanges
8
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
9
Internal Revenue Service. Instructions for Form 8824
10
Franchise Tax Board. 2025 California Tax Rate Schedules
11
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent