A 1031 exchange lets you sell a California rental and defer both the federal and California tax on the gain, if you buy another investment property through a qualified intermediary, identify it within 45 days and close within 180 days. California follows the federal rules, but if the replacement is in another state you must file FTB Form 3840 every year until the deferred California gain is taxed. It suits an owner who wants a different rental; it doesn't suit one who wants out of being a landlord.
You own a rental in or around Sacramento, you've heard a 1031 exchange can avoid the tax on a sale, and you want to know the rules and whether it makes sense for you.
1031 exchange rules in California at a glance
| What qualifies | Real property held for investment or business, for other such real property (personal property excluded since 2018) |
|---|---|
| Identify the replacement | In writing within 45 days of selling |
| Close on the replacement | Within 180 days, or your tax return due date if earlier |
| Who holds the money | A qualified intermediary; you can't touch the proceeds |
| Full deferral | Buy at least the net sale price, reinvest all the cash, replace the debt |
| Out-of-state replacement | File FTB Form 3840 every year until the California gain is taxed |
| Form 593 withholding | Not withheld on a valid exchange; withheld on boot over $1,500 |
How a 1031 exchange works: the federal rules
IRC section 1031 lets you swap one investment property for another and carry the old gain into the new one instead of paying tax on it now. Most exchanges today are deferred: you sell first, and the intermediary buys the replacement for you later. Each rule below is a pass-or-fail test.
Like-kind real property for a 1031 exchange
Since 2018, section 1031 applies only to real property held for use in a business or for investment, and not to property held primarily for sale (IRS Form 8824 instructions). Any investment real estate is like-kind to any other: a Sacramento house can become a duplex, land or a commercial building. A house you lived in only as your residence doesn't qualify.
45-day identification rule
Within 45 days of closing your sale, you must identify the replacement in a signed, written document delivered to the intermediary or seller. IRS Publication 544 limits you to three properties of any value, or any number whose total value is no more than double what you sold, with a 95% exception if you buy almost everything you named.
180-day exchange deadline
You must receive the replacement within 180 days of the sale, or by your tax return due date with extensions, whichever is earlier. A rental sold in late 2026 can hit the return deadline before day 180 unless you extend. There's no extension for a slow lender or a busy escrow.
Qualified intermediary in a 1031 exchange
The sale money goes to a qualified intermediary under a written exchange agreement and stays there until the replacement closes. If you take possession of the proceeds, the deal becomes a sale. Under Publication 544, anyone who acted as your agent, attorney, accountant or real estate broker in the two years before the sale is a disqualified person who can't serve. Choose an intermediary with your CPA and attorney, and ask how client funds are held, bonded and insured; Justin doesn't recommend specific intermediaries.
1031 exchange value, equity and debt rule
To defer all of the gain, buy a replacement that costs at least your net sale price, reinvest all the cash, and replace any mortgage you paid off with new debt or added cash. Net debt relief counts as money received in the Form 8824 instructions.
Boot: the taxable part of a 1031 exchange
Cash you keep or debt you don't replace is boot, and it's taxed in the year of the exchange. Publication 544 notes it can be taxed as depreciation recapture first. The how depreciation recapture is taxed shows how that slice is taxed.
California 1031 exchange rules: conformity, FTB 3840 and Form 593
California follows section 1031, and FTB's 2025 instructions confirm that for tax years from 2025, California like-kind exchanges are limited to real property, matching federal law. Three state rules add work.
FTB Form 593 on a 1031 exchange
A valid deferred exchange is exempt from the 3⅓% California withholding at the initial sale. But if you receive more than $1,500 of cash or other property, the intermediary must withhold, and if the exchange fails, it withholds 3⅓% of the sale price.
FTB Form 3840 when the replacement is out of state
If you exchange California property for property outside California, you must file FTB Form 3840 for the year of the exchange and every year after, generally until the California-source deferred gain is recognized. FTB treats the gain's California source as preserved, so when you sell the Arizona or Texas replacement years later, California taxes its share. If you don't file, FTB may estimate the income and assess tax, penalties and interest. That's the clawback people mean.
Prop 13 reassessment of the replacement property
A 1031 exchange defers income tax, not property tax. Buying the replacement is a change in ownership, and under Prop 13 the county assessor reassesses it to current market value, according to the Board of Equalization. A Sacramento rental bought years ago may carry a low assessed value; the replacement starts fresh at its price, so the property tax bill on the new rental is usually higher.
The Sacramento property tax guide compares an owner's bill with a buyer's, and the 1031 exchange out of California guide covers the yearly Form 3840 filing and what triggers the tax later.
1031 exchange example: a Sacramento-area rental
Assumptions, labelled. You sell a West Sacramento rental for $520,000, close to Zillow's September 2026 typical value of $520,898 there. Selling costs are $32,000 and the loan payoff is $180,000, so the intermediary receives $308,000. Your net sale price is $488,000.
| Replacement purchase | New loan | Cash kept | Taxable boot |
|---|---|---|---|
| $560,000 with all $308,000 down | $252,000 | $0 | $0, fully deferred |
| $560,000, taking $40,000 out at closing | $292,000 | $40,000 | $40,000 |
| $450,000 with all $308,000 down | $142,000 | $0 | $38,000 of debt relief |
In the third row you paid off $180,000 of debt and took on $142,000, so the $38,000 difference is taxed even though you received no cash. The tax on any boot follows the same federal and California lines as an ordinary sale, explained in the capital gains on a California rental guide.
Delaware statutory trusts as a 1031 exchange option
A Delaware statutory trust (DST) owns large properties such as apartment complexes, and investors buy fractional interests. In Rev. Rul. 2004-86, the IRS ruled that an interest in a DST structured as that ruling describes can be acquired in a 1031 exchange without recognizing gain.
What a DST 1031 exchange offers
No tenants, repairs or calls: a sponsor manages the property. You can buy an interest sized to your exact exchange funds, which helps you meet the 45-day deadline and avoid boot.
What a DST 1031 exchange gives up
You have no control over the property, its debt or when it's sold, and interests are hard to sell early. The sponsor's fees come out of your return. A DST is an investment decision, so read the offering documents and get advice from a CPA and a financial adviser who isn't paid on the sale.
What a 1031 exchange costs in California
No state agency publishes an average cost, and quoted figures vary, so get written quotes. The cost lines are predictable.
Qualified intermediary fees for a 1031 exchange
The intermediary charges a fee to set up and run the exchange. Ask for every fee in writing, and ask who keeps any interest earned on your funds while they're held.
Two sets of closing costs in a 1031 exchange
You pay selling costs on the old rental and buying costs on the new one: escrow, title, loan fees and any transfer tax. The Sacramento selling-cost guide lists the sale side line by line.
The cost of a failed 1031 exchange
Miss the 45-day or 180-day deadline and the sale is taxed as if you never tried. Plan the replacement search before you list.
When a 1031 exchange doesn't fit a tired Sacramento landlord
The exchange keeps you in the rental business. If you're selling because you're done with tenants, repairs or California's rules, it moves the problem to a new address, with a higher property tax bill and a new loan. Pick the exchange if you want a newer house, a different city or a property that fits retirement better. Pick a sale if you want to be finished; the tax is real, but so is the freedom. The tired landlord page covers selling to be done, and whether to sell your rental helps you decide between keeping, exchanging and selling.
Either way, line it up before you list. An exchange needs the intermediary in place before your sale closes, and a sale with a tenant in place reaches a different set of buyers; the site's guide to selling a Sacramento rental covers both. This is general information, not tax or legal advice; ask a CPA or real estate attorney before you start an exchange.
1031 exchange California questions
How do I avoid capital gains tax on property in California?
For a rental, the main tool is a 1031 exchange, which defers both the federal and California tax if you buy another investment property within the deadlines. Heirs who inherit get a stepped-up basis that wipes out the gain. For a home you lived in, section 121 can exclude up to $250,000 or $500,000 of gain. California has no lower rate, so outright sales are taxed as ordinary income.
What is the downside of a 1031 exchange?
You stay a landlord, the tax is deferred rather than forgiven, and the deadlines are strict: 45 days to identify and 180 days to close, with no extensions for delays. The replacement is reassessed under Prop 13, so property tax usually rises. Cash or debt relief you take is taxable boot, and an out-of-state replacement means filing FTB Form 3840 every year.
What is the 2-year rule for a 1031 exchange?
It usually means the related-party rule. If you exchange with a relative or related company and either of you disposes of the property within two years, the deferred gain becomes taxable, with limited exceptions. Section 1031 itself sets no fixed holding period, but the property must be held for investment, and the IRS has a safe harbor for dwelling units in Rev. Proc. 2008-16. Ask a CPA.
How much does it cost to do a 1031 exchange in California?
There's no official average. You'll pay a qualified intermediary's fee, closing costs on both the sale and the purchase, loan costs on any new mortgage, and possibly professional fees for a CPA or attorney. Ask who keeps any interest on your funds. Get written quotes, and remember that a failed exchange costs the full tax you were trying to defer.
Can I do a 1031 exchange from California to another state?
Yes. Federal law treats real property anywhere in the United States as like-kind. California then requires you to file FTB Form 3840 for the year of the exchange and every year after until the California-source deferred gain is recognized. When you later sell the out-of-state property in a taxable sale, California taxes the gain that came from the California rental.
Is a 1031 exchange exempt from California withholding?
A valid exchange is exempt from the 3⅓% Form 593 withholding at the sale. If you receive more than $1,500 in cash or other non-like-kind property, the intermediary must withhold on it. If the exchange fails, the intermediary withholds 3⅓% of the sale price. Either way, the withholding is a credit on your California return.
Can I 1031 exchange a rental into a house I'll live in?
Not directly. The replacement must be held for investment, so buying a house to move into doesn't qualify. Some owners rent the replacement first and convert it later, which brings in section 121 and the nonqualified use rules, and the timing matters. The safe harbor and five-year rule are in <a href="/guides/1031-exchange-rental-to-primary-residence/">moving into a 1031 replacement property</a>.
Sources
- IRS Instructions for Form 8824: Like-kind exchanges
- IRS Publication 544: Sales and other dispositions of assets (identification rules, boot)
- IRS Rev. Rul. 2004-86, Internal Revenue Bulletin 2004-33 (Delaware statutory trusts)
- FTB: 2025 Form 3840 instructions, California like-kind exchanges
- FTB: 2026 Form 593 instructions (exchanges, boot over $1,500)
- California Board of Equalization: Change in ownership FAQs
- California Lawyers Association: What is a 1031 exchange?
Reviewed by Justin Vierra
Justin reviewed this page for accuracy on October 28, 2026. Figures come from the sources listed above. Our research process.
Justin Vierra is a Sacramento Realtor® with GUIDE Real Estate and Principal of the Vierra Group who sells rental homes for their owners, with tenants in place or vacant. He spent six years in Midtown property management before he began selling homes in 2010.
- Since 2010Licensed in California, DRE #01880488
- 6 yearsManaging Midtown rental property before he sold homes
- 447Vierra Group team sales on Zillow, 26 in the past 12 months
- 440+Career sales, as reported by Justin
- Six years in property management: Midtown Sacramento: older buildings, multifamily property, maintenance and tenants
- Principal, Vierra Group: His team at GUIDE Real Estate, 3001 I Street, Sacramento
- Sacramento Real Producers: Top 250 agent for 2025, as reported by Justin
Realtor®, DRE #01880488. Vierra Group, GUIDE Real Estate, 3001 I St, Suite 200, Sacramento, CA 95816. General information, not legal, tax or financial advice.
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