What is a §1031 exchange?

A §1031 exchange, named for Internal Revenue Code §1031, lets a real-property investor defer capital-gains tax by reinvesting the proceeds from a sold investment property into like-kind replacement property, rather than taking cash and paying tax. The gain is deferred, not erased — it carries into the new property's basis. California conforms to §1031, so a proper exchange defers both federal and California tax.

What are the 45-day and 180-day rules?

After the relinquished property closes, the investor has 45 days to identify replacement property in writing and 180 days to close on it. The two periods run concurrently from the same closing date, so the 180 days is not added to the 45. Both deadlines are strict; missing either generally makes the deferred gain taxable. The proceeds must also be held by a qualified intermediary throughout.

What is a qualified intermediary?

A qualified intermediary is a neutral third party who holds the sale proceeds from the relinquished property and transfers them into the replacement purchase, so the investor never takes actual or constructive receipt of the money. This is essential: if the investor receives the proceeds, even briefly, the exchange fails and the entire gain becomes taxable. The intermediary is what makes a delayed exchange possible.

What is California's 3⅓% withholding, and how do I avoid it?

When California real estate is sold, the state generally requires withholding of 3⅓% of the gross sales price at closing. A 1031 exchanger avoids it by certifying the like-kind exchange on Franchise Tax Board Form 593 before escrow closes and delivering it to the escrow holder or qualified intermediary. Done correctly, no withholding is taken. If Form 593 is missing or late, withholding is automatic and must be recovered later by filing a California return.

What is the California clawback?

Under Revenue and Taxation Code §18032, when an investor exchanges California property for out-of-state replacement property, California continues to claim tax on the gain that accrued while the property was in California. The investor — resident or non-resident — must file Franchise Tax Board Form 3840 annually until the deferred gain is recognized. If filing stops, the Franchise Tax Board may treat the gain as recognized and assess the tax.

Can I exchange a rental property for raw land?

Yes. For real estate, like-kind is interpreted broadly: any real property held for investment or business use is like-kind to any other such real property, regardless of type. A rental property can be exchanged for raw land, a commercial building, or another rental. The property must be held for investment or business, not personal use, and since 2017 only real property — not personal property — qualifies for §1031.

1031 Exchange in California: Rules, 593 & Clawback

TL;DR

A §1031 exchange lets a real-property investor defer capital-gains tax by rolling the proceeds of a sold investment property into a new "like-kind" investment property, instead of taking cash and paying tax. The rule is federal — Internal Revenue Code §1031 — and California conforms to it, so a properly structured exchange defers both federal and California tax. Like-kind is read broadly for real estate: almost any real property held for investment or business use can be exchanged for almost any other, so an apartment building can be exchanged for raw land or a commercial building. The core mechanics are strict deadlines: after selling the relinquished property, the investor has 45 days to identify replacement property in writing and 180 days to close on it, and the proceeds must be held by a qualified intermediary — never received by the investor — or the exchange fails. California adds two state-specific layers. First, on any sale of California real estate, the state requires withholding of 3⅓% of the sales price at closing; a 1031 exchanger avoids this by certifying the exchange on Franchise Tax Board Form 593 before escrow closes. Second, California's "clawback" rule (Revenue and Taxation Code §18032) applies when an investor exchanges California property for out-of-state replacement property: the investor must file FTB Form 3840 every year until the deferred gain is finally recognized, because California continues to claim the tax on gain that accrued while the property was in California.

What a §1031 exchange does

Ordinarily, selling an investment property for more than its adjusted basis produces a taxable capital gain. Internal Revenue Code §1031 offers an alternative: if the investor reinvests the proceeds into like-kind property rather than pocketing them, the tax on the gain is deferred rather than paid now. The gain does not disappear — it carries into the new property's basis — but the investor keeps the full proceeds working instead of losing a slice to tax at each sale.

California generally conforms to §1031 for current real-property exchanges, so a properly structured real-property exchange can defer California income tax along with the federal tax. Older exchanges can involve California-specific conformity rules, especially for personal property, but current exam treatment should focus on real property. The deferral is what makes the tool powerful: an investor can trade up through successively larger properties over decades without paying gain tax at each step, as long as each transaction meets the §1031 rules.

Like-kind property

For real estate, "like-kind" is interpreted broadly. Any real property held for productive use in a trade or business or for investment is like-kind to any other such real property. The properties do not have to be the same type: an investor can exchange an apartment building for raw land, a retail building for a warehouse, or a rental house for a fractional interest in a larger commercial property.

The important limits are on use and location. The property must be held for investment or business use, so a personal residence does not qualify. And since the 2017 federal tax changes, only real property qualifies for §1031 — exchanges of personal property or equipment no longer qualify. For how the gain that is deferred here interacts with the property-tax basis of the acquired property, a separate system, see our guide to Proposition 13 property-tax assessment.

The 45-day and 180-day deadlines

The mechanics of a delayed exchange run on two strict, simultaneous clocks that both start on the day the relinquished property closes. Within 45 days, the investor must identify the potential replacement property in writing, following identification rules that limit how many properties may be listed. Within 180 days, the investor must close on the replacement property. The 180-day period is not extended by the 45 days — they run together, so once 45 days pass the investor has 135 remaining to close.

These deadlines are unforgiving; missing either one generally defeats the exchange and makes the gain taxable. The other non-negotiable rule is that the investor may not take actual or constructive receipt of the sale proceeds. The money must be held by a qualified intermediary — a neutral third party who holds the funds and transfers them into the replacement purchase. If the investor touches the proceeds, the exchange fails and the entire gain becomes taxable. For how the earnest-money and closing structure of the underlying purchase is handled, see our guide to liquidated damages and earnest money.

Requirement	Rule
Identify replacement property	Within 45 days of closing the relinquished property
Close on replacement property	Within 180 days (runs concurrently with the 45)
Hold the proceeds	Qualified intermediary — investor may never receive them
Property use	Held for investment or business, not personal use

California withholding and Form 593

California adds a withholding layer at closing that exchangers must manage. When California real estate is sold, the state generally requires withholding of 3⅓% of the gross sales price, collected at closing so the state secures its tax before proceeds leave. On a large sale that withholding can tie up a substantial sum — exactly the cash a 1031 exchanger needs available for reinvestment.

The exchanger avoids the withholding by certifying, on Franchise Tax Board Form 593, that the transaction is a like-kind exchange under §1031. The certification is completed and delivered to the escrow holder or qualified intermediary before escrow closes; done correctly, no withholding is taken and the full proceeds move to the intermediary for reinvestment. If the certification is missing or late, the withholding happens automatically, and recovering it requires filing a California return and waiting for a refund. For the disclosure obligations a seller carries into that same closing, see our guide to the Transfer Disclosure Statement.

The California clawback: §18032 and Form 3840

California's most distinctive 1031 rule is the "clawback," in Revenue and Taxation Code §18032. Gain that accrued while a property sat in California is California-source income. When an investor exchanges California property for replacement property located outside California, deferring the gain does not change its source — California continues to claim the right to tax that gain whenever it is eventually recognized.

To enforce this, §18032 requires the investor — resident or non-resident — to file an annual information return, Franchise Tax Board Form 3840, for the year of the exchange and every year afterward until the deferred California gain is finally recognized. If the investor stops filing, the Franchise Tax Board may treat the gain as recognized and assess the deferred tax. The clawback means an investor who exchanges out of California carries a California filing obligation that follows the gain indefinitely, no matter where the investor or the replacement property later sits.

Frequently Asked Questions

What is a §1031 exchange?: A §1031 exchange, named for Internal Revenue Code §1031, lets a real-property investor defer capital-gains tax by reinvesting the proceeds from a sold investment property into like-kind replacement property, rather than taking cash and paying tax. The gain is deferred, not erased — it carries into the new property's basis. California conforms to §1031, so a proper exchange defers both federal and California tax.
What are the 45-day and 180-day rules?: After the relinquished property closes, the investor has 45 days to identify replacement property in writing and 180 days to close on it. The two periods run concurrently from the same closing date, so the 180 days is not added to the 45. Both deadlines are strict; missing either generally makes the deferred gain taxable. The proceeds must also be held by a qualified intermediary throughout.
What is a qualified intermediary?: A qualified intermediary is a neutral third party who holds the sale proceeds from the relinquished property and transfers them into the replacement purchase, so the investor never takes actual or constructive receipt of the money. This is essential: if the investor receives the proceeds, even briefly, the exchange fails and the entire gain becomes taxable. The intermediary is what makes a delayed exchange possible.
What is California's 3⅓% withholding, and how do I avoid it?: When California real estate is sold, the state generally requires withholding of 3⅓% of the gross sales price at closing. A 1031 exchanger avoids it by certifying the like-kind exchange on Franchise Tax Board Form 593 before escrow closes and delivering it to the escrow holder or qualified intermediary. Done correctly, no withholding is taken. If Form 593 is missing or late, withholding is automatic and must be recovered later by filing a California return.
What is the California clawback?: Under Revenue and Taxation Code §18032, when an investor exchanges California property for out-of-state replacement property, California continues to claim tax on the gain that accrued while the property was in California. The investor — resident or non-resident — must file Franchise Tax Board Form 3840 annually until the deferred gain is recognized. If filing stops, the Franchise Tax Board may treat the gain as recognized and assess the tax.
Can I exchange a rental property for raw land?: Yes. For real estate, like-kind is interpreted broadly: any real property held for investment or business use is like-kind to any other such real property, regardless of type. A rental property can be exchanged for raw land, a commercial building, or another rental. The property must be held for investment or business, not personal use, and since 2017 only real property — not personal property — qualifies for §1031.

Bottom Line

A §1031 exchange defers capital-gains tax by reinvesting the proceeds of a sold investment property into like-kind replacement property, under Internal Revenue Code §1031, and California conforms so a proper exchange defers both federal and state tax. Like-kind is broad for real estate — any investment or business real property for any other — but personal residences do not qualify, and since 2017 only real property qualifies. The mechanics are strict: 45 days to identify replacement property, 180 days to close (running concurrently), and the proceeds must be held by a qualified intermediary the investor never touches. California layers on a 3⅓% withholding at closing that an exchanger avoids by filing Franchise Tax Board Form 593 before escrow closes, and a clawback under Revenue and Taxation Code §18032 that requires filing Form 3840 every year when California property is exchanged for out-of-state replacement property, because California keeps its claim on the California-source gain. For related California topics, see our guides to Proposition 13 property-tax assessment, liquidated damages and earnest money, and the Transfer Disclosure Statement.

Source: 26 U.S.C. §1031 — Like-kind exchanges (Cornell) · California FTB — Reporting like-kind exchanges (Form 3840) · California FTB — Real estate withholding (Form 593)