1031 exchange in
California.

Does California follow federal 1031 rules?

California has an active clawback regime (FTB Form 3840). When you 1031-exchange California-source property into non-California replacement property, California tracks the deferred gain and taxes it when the replacement is eventually sold outside an exchange — even if you have moved away from California. Annual information returns are required during the deferral period.

How the California clawback works

California's clawback regime is the most aggressive in the country. When you exchange CA-source real property into non-CA replacement, the California-source deferred gain is tracked by the FTB and taxed when the replacement property is eventually sold outside a qualifying 1031 exchange — even if you have long since moved out of California and have no other CA-source income. The mechanism: FTB Form 3840 (California Like-Kind Exchanges) must be filed for the tax year of the exchange and for every subsequent tax year until the deferred CA-source gain is recognized. For calendar-year filers the 2026 deadline is April 15, 2026 (October 15 with extension). Failure to file Form 3840 can trigger a Notice of Proposed Assessment and immediate recognition of the full deferred CA gain plus penalties and interest — even though no taxable event has otherwise occurred. The trap: out-of-state CPAs routinely miss the annual Form 3840 in years 2, 3, 4 of the deferral chain because there's no triggering federal event. Maintain a 3840-tracking file independently of your annual tax software.

California capital gains tax structure

California taxes capital gains as ordinary income with a top bracket up to 13.3% (2026). No preferential long-term rate.

California's top marginal rate of 13.3% (12.3% top bracket plus a 1% Mental Health Services tax on income above $1M) applies to capital gains at the same rate as ordinary income — there is no preferential long-term rate. The 1% MHS surtax kicks in on every dollar above $1M, so a large 1031 boot or eventual recognition can push a meaningful share into the surtax. California does not conform to federal QSBS exclusion in full and treats many federal preferences differently — your CA-basis arithmetic is not your federal-basis arithmetic, and that gap matters in any 1031 chain. Estimated tax payments are due quarterly with a heavily front-loaded schedule (30/40/0/30) that catches out-of-state taxpayers off guard. Add CA's notoriously aggressive residency-audit posture for any year you exit the state.

Federal tax treatment of a successful 1031 is deferral of capital gain and unrecaptured Section 1250 depreciation recapture (federally taxed at a maximum 25% when eventually recognized). California's state treatment sits on top of those federal rates.

Non-resident withholding in California

California requires withholding at closing on sales of CA real property by non-residents and certain CA residents. The default rate is 3.33% of gross sales price (Form 593), unless the seller certifies an alternative gain-based calculation or claims an exemption. For a 1031 deferred exchange, the QI files Form 593 certifying the exchange and the sale is exempt from withholding at the time of the initial transfer — but if the seller receives more than $1,500 of money or other property in addition to like-kind property (i.e., boot), the QI must withhold on the boot. If the exchange fails or the seller doesn't complete a qualifying replacement, the QI must withhold 3.33% of sales price after the fact. Form 593 must be properly executed and filed at the closing — not after.

Common 1031 replacement strategies in California

California 1031 sellers fall into three buckets. (1) Stay-in-state buyers — Class A multifamily in coastal LA, San Diego, and the Bay Area at 4.5-5.5% caps; Inland Empire industrial at 4.5-5% on credit-tenant logistics; Sacramento Class B multifamily at 5.5-6.5%. The state premium is real and it's the trade-off for avoiding the 3840 clawback paperwork. (2) Out-of-state exit — Phoenix, Las Vegas, Dallas, Austin, and Boise are the popular destinations, but the FTB clawback follows the deferred CA-source gain into perpetuity until eventual recognition outside an exchange. (3) DST exit — fractional DST interests are a popular CA exit for sellers who want passive income, want to defer tax, and don't want to land another active deal; CA conforms to federal DST treatment and the clawback follows into the DST. Inland Empire industrial has been the country's hottest CRE story for five years, but the 2024-2025 reset (vacancy back to 7.2%, rents down 30%+ from 2023 peak) has reset that thesis — buy the dip if you're local; don't extrapolate the 2019-2022 numbers.

Top California CRE markets for 1031 buyers

Los Angeles

Massive 1031 source market. Class B multifamily across the broader LA basin trades 5-6% caps on rent-controlled (RSO) inventory and 4.5-5.5% on non-RSO; tenant protections (LARSO, statewide AB 1482, just-cause eviction) materially affect underwriting and rent-growth assumptions. Class A urban infill in DTLA, Hollywood, and Westside coastal multifamily trades 4-5% on stabilized core. Industrial in the Mid-Cities and South Bay near the ports trades 4.25-5% — still tight but with meaningful softening through 2024-2025 as port-adjacent logistics demand reset.

San Francisco Bay Area

The SF metro is bifurcated. Class A multifamily in SF proper, Oakland, and SJ trades 4.25-5% on stabilized non-rent-controlled product; rent-controlled SF multifamily can trade tighter on a per-door basis but is a specialist game given Prop M, Costa-Hawkins limitations, and aggressive tenant attorneys. The South Bay tech-anchored office market is in distress with vacancy north of 30% in many submarkets; office is not a credible 1031 target absent a specialist value-add thesis. Industrial in Hayward, Fremont, and Newark trades 4.5-5.5% on credit-tenant product.

San Diego

Class A multifamily in coastal La Jolla, UTC, and downtown trades 4.25-5%; Class B in inland submarkets (El Cajon, Chula Vista) holds 5.5-6.25%. Biotech-adjacent flex/lab space in Sorrento Mesa and Torrey Pines is its own asset class, generally trading at premium pricing for credit-tenant lab. Military and federal tenancy supports retail and small-bay industrial demand near the Navy and Marine bases.

Sacramento

Sacramento has been the CA value market for the last decade — Class B multifamily at 5.5-6.5%, retail and small-bay industrial at 6-7%. State-government employment provides demand stability that the major coastal metros lack. Sacramento has been a popular intra-CA 1031 destination for sellers exiting LA or SF coastal product who want yield without leaving the state and triggering 3840 clawback paperwork.

Orange County

Class A coastal multifamily in Newport Beach, Irvine, and Huntington Beach trades 4-4.75% on stabilized core; B product inland (Anaheim, Garden Grove, Santa Ana) holds 5-6%. Office in Irvine and Newport has held up better than LA or SF but is still in a tenant's market through 2024-2025. NNN retail along PCH and major arterials trades 4.5-5.5% on national-credit tenants — the OC retail premium is real and persistent.

Inland Empire

The country's most-discussed industrial market, and the one where the cycle most clearly inflected. Big-box logistics absorbed at unprecedented rates 2019-2022; vacancy ballooned to 7.2% by Q4 2025 and rents fell 30%+ from the 2023 peak of $1.57/SF NNN to roughly $1.03/SF. Q3 2025 sales pricing averaged $266/SF at 4.7% caps. The 'land-constrained submarkets' thesis is back in question. For 1031 buyers: target stabilized credit-tenant core-plus, not speculative spec or development land.

Local counsel, recording, and filing in California

Two CA closing realities trip up out-of-state attorneys. First, California uses escrow agents (not attorneys) to close real estate transactions in most counties — the escrow officer is a licensed escrow company, not your QI and not your lawyer. Second, title insurance is issued by major title companies on competitive (non-rate-regulated) terms; shop. CA is a community property state, with critical step-up implications at first death (full step-up on both halves of community property — a major planning interaction with deferred 1031 gain). For LA and SF closings, retain a CA-licensed real estate attorney who actively practices in the relevant rent-control and just-cause-eviction regime; underwriting multifamily without a local counsel review of tenant protections is malpractice.

Recent developments in California

The FTB has continued aggressive enforcement of Form 3840 non-filers through 2024-2025, including issuing Notices of Proposed Assessment to taxpayers who completed CA 1031 exchanges in earlier years and let the annual filing lapse. There is no statute of limitations friendly to non-filers — the assessment clock effectively doesn't start until the 3840 is filed. The 2024 Form 593 instructions and 2026 Form 593 instructions maintain the same exchange-exemption procedure: the QI executes Form 593 at closing certifying the 1031 exchange, and withholding is waived on the like-kind portion (boot is still withheld). Watch for any FTB guidance on Inland Empire industrial valuations as cap rates have widened significantly through 2024-2025; the FTB may revisit certain real-estate-related rulings.

Common mistakes in California 1031 exchanges

• Failing to file FTB Form 3840 every year of the deferral. The single most common CA 1031 disaster. After year 1, when there's no federal triggering event, out-of-state CPAs miss the annual 3840 filing. The FTB does not require a triggering event — the form is required every year until CA-source deferred gain is recognized. Miss it and the FTB can assess the full deferred gain plus penalties and interest, even though you've done nothing wrong on the federal side. Maintain an independent 3840 tracking file and treat the April 15 / October 15 deadline as load-bearing.
• Confusing Form 593 withholding exemption with the FTB 3840 clawback. Form 593 is the closing-time withholding statement (3.33% of gross sales price unless the seller exempts out via like-kind exchange certification). FTB Form 3840 is the annual ongoing tracking return for the deferred CA-source gain. They are entirely different filings, and exempting from 593 at closing does NOT satisfy the 3840 obligation — you still owe annual 3840s every year of the deferral chain. CA-experienced CPAs know this; out-of-state CPAs frequently conflate the two.
• Triggering Prop 19 reassessment when transferring 1031 property to a child. Prop 19 (effective 2/16/21) gutted the old parent-child reassessment exclusion for non-primary-residence property. Transferring 1031'd CA investment property to your kids — including via gifting or estate-planning structures — triggers a full property-tax reassessment to current market value. Combined with potential CA-source clawback at recognition, intergenerational planning for CA 1031 portfolios is materially harder post-Prop 19 than before. Get CA estate counsel involved before you set up any family transfer of 1031'd property.

What to do if you're starting a California-source 1031

1. Engage a Qualified Intermediary before the downleg closes. Your QI cannot be a disqualified person (attorney, CPA, or real estate agent who has represented you in the last two years).
2. Confirm state conformance and any clawback or withholding filings with a California-licensed CPA. California's active clawback regime makes this non-optional.
3. Identify replacement property within 45 days in writing, delivered to your QI, under the Three-Property Rule or one of the alternative identification rules.
4. Close on replacement within 180 days of the downleg closing or by your federal tax-return due date (with extensions), whichever is earlier.
5. File Form 8824 with your federal return reporting the exchange. File any required California state forms for the year, including any clawback or withholding-exemption filings.

FAQ: 1031 exchanges in California

What is FTB Form 3840 and when do I have to file it?

FTB Form 3840 (California Like-Kind Exchanges) is California's annual tracking return for any 1031 exchange where CA-source real property was relinquished and out-of-state replacement property was acquired. You must file Form 3840 for the tax year of the exchange and every subsequent tax year until the CA-source deferred gain is recognized — typically when the replacement property is eventually sold outside another qualifying 1031 exchange. Calendar-year deadline is April 15 (October 15 with extension). Failure to file can trigger a Notice of Proposed Assessment for the full deferred gain plus penalties and interest.

Why is Nevada so popular as a California 1031 destination?

No state income tax in NV (versus 13.3% top in CA), landlord-friendly regulatory environment, contiguous geography for CA-based ownership/management, and depth of inventory in Las Vegas and Reno. The catch: California's clawback (Form 3840) follows the CA-source deferred gain into NV. When you eventually sell the NV replacement outside an exchange, CA reaches back and taxes the original CA-source gain — even if you've moved to NV permanently. NV is a deferral and lifestyle play, not a clawback escape. Combined with a long hold and a step-up on death for community property, the strategy still works for many CA exiters; just don't pretend the clawback isn't there.

If I move out of California permanently, does the clawback still apply?

Yes. The clawback is tied to the CA-source character of the original deferred gain, not to your residency. As long as you have CA-source deferred gain in a 1031 chain, you owe annual Form 3840 filings and will owe CA tax on eventual recognition outside an exchange. Moving to TX, FL, or NV does not erase the CA-source character of the deferred gain. The only way out is to die holding the property (basis step-up wipes the deferred gain) or to recognize the gain in a year where CA exclusions or rate changes happen to be favorable.

How does Form 593 withholding work for a California 1031 exchange?

California requires 3.33% of gross sales price to be withheld at closing on most CA real estate sales by non-residents and certain residents (Form 593). For a 1031 deferred exchange, the QI executes Form 593 at closing certifying the exchange — and the like-kind portion of the sale is exempt from withholding. Boot (cash or other non-like-kind property received in excess of $1,500) is still subject to withholding. If the exchange fails or you don't complete qualifying replacement, the QI is required to withhold 3.33% of the sales price after the fact. Get the 593 properly executed at closing — not after.

How does Proposition 19 interact with my 1031 deferred gain when I want to transfer property to my kids?

Badly. Prop 19 (effective February 16, 2021) eliminated the old parent-child reassessment exclusion for non-primary-residence property. Transferring 1031'd investment property to your children — by lifetime gift, sale, or trust distribution — triggers a full property-tax reassessment to current market value. The 1031 deferred income tax doesn't go away (basis carries over), but you also lose the Prop 13 protected basis on property tax. Combined with CA-source clawback liability still attached to the deferred gain, intergenerational CA real estate planning got materially harder post-Prop 19. Use CA estate counsel; do not attempt this with a generic out-of-state estate plan.

Is a California-resident DST a way around the clawback?

No. A 1031 exchange into a DST holding non-CA replacement property still triggers Form 3840 annual filings and the clawback follows the deferred CA-source gain into the DST. The DST sponsor's eventual disposition (typically a 721 UPREIT contribution or outright sale) is the recognition event that lights up the clawback — and many CA-source DST investors have been surprised by the resulting CA tax bill years later. DSTs are a credible passive-income exit, but they don't escape the FTB. CA-source DST investors should plan for the eventual clawback recognition, not pretend it isn't coming.