A 1031 exchange in California carries the highest stakes in the country, because California taxes the gain on a property sale as ordinary income at rates up to 13.3%, on top of the federal tax. For an investor with significant appreciation, deferring that combined bill through an exchange can preserve more capital here than almost anywhere else. Two rules unique to California shape every exchange in the state: a mandatory 3.33% withholding at closing, and the FTB 3840 clawback, which keeps California's claim on your deferred gain alive even after you sell and reinvest in another state. We act as your qualified intermediary and coordinate both alongside the federal exchange.
Table of contents
- What is a 1031 exchange?
- How much is capital gains tax on real estate in California?
- California's 3.33% real estate withholding and the 1031 exemption
- The FTB 3840 clawback: California's claim follows you out of state
- California 1031 exchange rules and timeline
- Why your qualified intermediary matters more in California
- California property tax and a 1031: Proposition 13 works in your favor
- Where California investors exchange
- Common California 1031 exchange mistakes
- Start your California 1031 exchange
- Frequently asked questions
What is a 1031 exchange?
A 1031 exchange lets you sell investment or business real estate and reinvest in like-kind real property while deferring the tax on the gain, rather than recognizing it at the sale. The deferred tax carries into the basis of the replacement property. To defer the full gain you reinvest all net proceeds, acquire property of equal or greater value, and replace the debt you carried, and the same taxpayer that sold must acquire. A qualified intermediary must hold the proceeds throughout. Our main 1031 exchange guide covers the federal framework in full; this page focuses on California, where the state rules add real complexity on top.
How much is capital gains tax on real estate in California?
California is the only thing that makes a 1031 here different from a 1031 anywhere else, and it starts with the rate. California does not have a separate, lower rate for capital gains. It taxes the gain as ordinary income, with no distinction between long-term and short-term, across brackets that run from 1% to 13.3%. The top 13.3% figure is the 12.3% top income bracket plus the 1% Mental Health Services Tax that applies to taxable income above $1,000,000. That is the highest state rate in the nation.
Stack that on the federal tax a sale also triggers, and the exposure is steep:
- Federal long-term capital gains at 0%, 15%, or 20%, with the 20% rate applying above $545,500 of taxable income for single filers and $613,700 for married couples filing jointly in 2026.
- The 3.8% Net Investment Income Tax, once modified adjusted gross income passes $200,000 (single) or $250,000 (married filing jointly).
- Depreciation recapture on the real property you have written off, taxed as unrecaptured Section 1250 gain at up to 25%.
- California's rate of up to 13.3% on the entire gain.
For a high-income California seller, the combined federal and state hit can exceed 37% of the gain. California conforms to Section 1031, so a properly structured exchange defers both the federal and the California tax. The catch is that California attaches two strings to that deferral, below.
California's 3.33% real estate withholding and the 1031 exemption
When California real estate sells, the state requires withholding of 3 1/3% (3.33%) of the gross sales price at closing, for both resident and non-resident sellers, reported on Form 593. This is not a separate tax, it is a prepayment against the tax on the sale, but it pulls cash at the closing table.
In a 1031 exchange you can claim an exemption by checking the exchange box on Form 593 before the sale closes, supported by your intermediary's exchange documentation, with the closing agent coordinating the filing. Missing that filing does not disqualify the exchange, but it means 3.33% of your sales price is withheld and then has to be reclaimed on your California return, which both disrupts the cash your intermediary needs to fund the purchase and ties up capital for months. Since 2022, a cash-poor transaction rule limits an intermediary's withholding obligation to the funds actually available where escrow has not provided enough, which your intermediary documents on Form 593.
The FTB 3840 clawback: California's claim follows you out of state
This is the rule California investors most often overlook, and it has no equivalent in a no-tax state. Under California Revenue and Taxation Code Sections 18032 and 24953, the Franchise Tax Board takes the position that the gain which accrued while a property sat on California soil belongs to California, regardless of where you later move or where your replacement property sits.
When you exchange California real estate for replacement property located outside California, you must file Form FTB 3840 for the year of the exchange and for every subsequent year, until the California-source deferred gain is recognized. It is an annual information return that tells the FTB you still hold the out-of-state property and have not cashed out. The obligation ends in only two ways: you sell the replacement property in a taxable transaction and pay California its share of the original deferred gain, or you hold until death, at which point your heirs take a stepped-up basis that generally clears the deferred tax. Investors call the second path "swap till you drop."
Enforcement has tightened sharply. In 2026 the FTB's Enterprise Data to Revenue system cross-references federal Form 8824 filings against California returns, so when the IRS shows a California property sold in an exchange but no Form 3840 appears on the California side, an automatic notice follows. If you fail to file, the FTB can issue a Notice of Proposed Assessment, estimate the income, and bill the full deferred gain plus penalties and interest. Our explainer on the California clawback walks through the filing in detail.
California 1031 exchange rules and timeline
The federal mechanics apply here as everywhere, and California layers its own forms on top:
- 45-day identification. Identify replacement property in writing within 45 days of the sale, under the three-property rule, the 200% rule, or the 95% rule.
- 180-day closing. Close within 180 days of the sale, or by your tax return due date including extensions, whichever is earlier.
- No constructive receipt. Proceeds go to your qualified intermediary, never to you.
- Equal or greater value and debt. Reinvest all net proceeds and match or exceed the relinquished property's value and debt, or the shortfall is taxable boot.
- Same taxpayer. The entity that sold must be the entity that buys.
- California forms. File Form 593 to claim the withholding exemption before close, report the exchange to the IRS on Form 8824, and file Form 3840 each year if the replacement property is out of state.
Why your qualified intermediary matters more in California
Every 1031 exchange needs a qualified intermediary to hold the proceeds, and the intermediary cannot be a disqualified person such as your agent, attorney, or a relative. California raises the bar, because your intermediary also coordinates the Form 593 withholding exemption with the closing agent and operates under the state's cash-poor withholding rule. A mishandled Form 593 means withheld cash and a stalled purchase, so the intermediary's familiarity with California closings matters as much as fund security.
We hold exchange funds in segregated, bonded accounts and coordinate the Form 593 exemption and the Form 3840 filing as part of every California exchange. You work directly with our exchange team from your first call through closing.
California property tax and a 1031: Proposition 13 works in your favor
In high-rate states, property tax is a drag on replacement-property yield. In California it is the opposite, and it is worth understanding if you are reinvesting within the state. Under Proposition 13, the base property tax is 1% of assessed value plus local voter-approved add-ons, the property is reassessed to its purchase price at acquisition, and annual increases are then capped at 2%. So a replacement property's tax is set against what you pay for it and barely rises afterward, which protects long-term yield in a way that market-reassessed states do not.
What a new buyer should budget by county, as an effective rate including local add-ons:
- Los Angeles: ~1.10% to 1.25%. City of LA adds the Measure ULA transfer tax (below)
- Orange: ~1.05% to 1.15%. Irvine and other newer Mello-Roos areas run higher
- San Diego: ~1.10% to 1.25%. Chula Vista and other CFD areas run higher
- Santa Clara: ~1.10% to 1.25%. High bills driven by high values, not high rates
- Alameda: ~1.20% to 1.30%. Among the higher effective rates in the state
- San Francisco: ~1.18%. City and county combined
- Sacramento: ~1.10%. Suburban Mello-Roos zones run higher
- Riverside: ~1.10% base. Mello-Roos zones can reach 1.5% or more
Confirm the exact rate per parcel, since Mello-Roos and Community Facilities District areas in places like Riverside, Sacramento suburbs, Irvine, and Chula Vista add meaningfully on top. These are effective-rate guides for a newly purchased property, not the lower figures often quoted for long-held, Prop 13-protected homes.
One California cost runs the other way and catches sellers in the City of Los Angeles. Measure ULA, the city transfer tax, adds 4% on property sales above $5,000,000 and 5.5% above $10,000,000. It is a transfer tax, not an income tax, so a 1031 defers your income tax but does not avoid ULA on a qualifying Los Angeles sale. Build it into the numbers before you list.
Where California investors exchange
A large share of California exchange activity is investors selling here and reinvesting in lower-tax states, most often Nevada, Texas, Arizona, and Florida, drawn by the absence of state tax on future income and on the eventual sale. The trade-off is the clawback: exchanging out of California triggers the annual Form 3840 obligation, while exchanging into another California property does not. Our California to Texas guide covers that corridor in full.
Within California, demand concentrates in a handful of markets. Los Angeles carries large multifamily and commercial volume, with two local factors to weigh: rent-stabilized buildings under the city's RSO, and the Measure ULA transfer tax on high-value sales. The San Francisco Bay Area runs on multifamily and commercial at high values. San Diego draws coastal, military, and biotech-adjacent demand. Orange County is a deep commercial and multifamily market. Sacramento and the Central Valley offer agricultural and industrial property at lower entry prices with faster growth. Whichever market you sell in, California's tax treatment of the gain is the same, and so is the 3840 obligation if you reinvest out of state.
Common California 1031 exchange mistakes
- Not filing the Form 593 exemption before closing, so 3.33% of the sales price is withheld and tied up for months.
- Forgetting Form 3840, which the FTB's data-matching now flags automatically.
- Assuming a move out of state, or an out-of-state replacement property, ends California's claim. It does not.
- Taking receipt of the proceeds, even briefly, which disqualifies the exchange.
- Missing the 45-day identification window.
- Trading down or pulling cash out, which creates taxable boot.
Start your California 1031 exchange
Set up your exchange before your relinquished property closes, so the Form 593 exemption is in place at the closing table and the proceeds never reach your hands. Contact our team to begin, or to talk through a specific deal.
Frequently asked questions
How much is capital gains tax on real estate in California?
California taxes the gain as ordinary income, with no lower long-term rate, at marginal rates up to 13.3% (12.3% plus a 1% Mental Health Services Tax on income over $1 million). That is on top of federal capital gains tax, so combined exposure can exceed 37% of the gain for high earners.
Does California tax a 1031 exchange?
California conforms to Section 1031, so a properly structured exchange defers both the federal and the California tax at the time of the sale. If your replacement property is outside California, you must then file Form 3840 every year until the deferred California gain is eventually recognized.
What is the FTB 3840 clawback?
It is California's rule that the gain accrued on a California property remains taxable by California even after a 1031 into another state. You file Form 3840 annually until you sell the replacement property in a taxable transaction and pay California, or hold it until death and pass a stepped-up basis to your heirs.
Is there withholding when I sell California property in a 1031?
Yes, California requires 3.33% of the sales price withheld at closing by default, on Form 593. In a 1031 you claim an exemption by checking the exchange box on Form 593 before close, coordinated by your intermediary and closing agent.
Can I do a 1031 exchange from California to Texas or Nevada?
Yes, and it is common. Section 1031 allows reinvesting anywhere in the US, so the exchange defers your federal and California tax. California's clawback still applies, so you file Form 3840 each year until you sell the out-of-state property without exchanging again.
Does California conform to federal 1031 rules?
Yes. The deferral works the same way at the state level. The differences are procedural: the Form 593 withholding exemption at closing and the Form 3840 annual filing for out-of-state replacement property.
What happens if I do not file Form 3840?
The FTB can issue a Notice of Proposed Assessment, estimate your income, and bill the full deferred gain plus penalties and interest. As of 2026 the state cross-references federal exchange filings against California returns, so a missing form is flagged automatically.
Do I need a qualified intermediary for a California 1031 exchange?
Yes. The intermediary must hold the proceeds and facilitate the exchange, and in California also coordinates the Form 593 withholding exemption. Engage one before the relinquished property closes.
This page is general information, not tax or legal advice. We act as a qualified intermediary and do not provide tax or legal advice. State and federal rules and thresholds change; confirm current figures with your tax advisor.
