A like-kind exchange lets you sell business or investment real estate and buy replacement property without paying tax on the gain right away. The tax is deferred, not forgiven, and the rules are strict. California adds a layer: if the replacement property is out of state, California tracks the gain and expects to tax it later.
What qualifies after 2017
For exchanges completed after December 31, 2017, Section 1031 applies only to real property. Gain or loss is not recognized when real property held for productive use in a trade or business or for investment is exchanged solely for like-kind real property held for the same purposes (IRC §1031(a)(1)).
- Not property held for sale. Real property held primarily for sale, such as a fix-and-flip, does not qualify (IRC §1031(a)(2)).
- U.S. for U.S. U.S. real property and foreign real property are not like-kind (IRC §1031(h)).
- California now matches. For taxable years beginning on or after January 1, 2025, California also limits like-kind exchanges to real property (FTB 3840 instructions).
The 45-day and 180-day deadlines
In a deferred exchange, you sell first and buy later. Two clocks start on the day you transfer the property you are giving up (IRC §1031(a)(3)):
- 45 days to identify. Replacement property must be identified in a signed writing delivered to someone involved in the exchange, such as the intermediary, who is not you or a disqualified person. You can generally identify up to three properties, or more if their total value is no more than 200 percent of the value of the property you sold (Treas. Reg. §1.1031(k)-1(c)).
- 180 days to close. You must receive the replacement property by the earlier of 180 days after the transfer or the due date, including extensions, of your return for that year.
For a calendar-year individual, a sale that closes after about mid-October can have its 180th day fall after the April filing deadline. Extending the return generally preserves the full 180 days (IRS Instructions for Form 8824). Property identified or received late is treated as not like-kind, so the gain is generally taxable.
The qualified intermediary and constructive receipt
Receiving the sale proceeds, or having them made available to you, before you receive the replacement property generally turns the exchange into a sale, and receipt by your agent counts as receipt by you (Treas. Reg. §1.1031(k)-1(f)).
That is why most deferred exchanges use a qualified intermediary. Under the regulations’ safe harbors, which include qualified intermediaries and qualified escrow accounts, you are not treated as receiving the money if a written agreement limits your access to it until the exchange ends (Treas. Reg. §1.1031(k)-1(g)).
The intermediary cannot be a disqualified person, which generally includes anyone who has acted as your employee, attorney, accountant, broker, or real estate agent within the two years before the transfer, with limited exceptions (Treas. Reg. §1.1031(k)-1(k)). This is one reason your regular tax advisor generally cannot serve as your intermediary.
Boot, and why the debt matters
Gain is recognized to the extent you receive cash or other property that is not like-kind, often called boot (IRC §1031(b)). Debt relief counts too: a liability of yours that the other party assumes is treated as money you received (IRC §1031(d)). On Form 8824, net liabilities are generally the debt you are relieved of, reduced by debt you take on and cash you add (IRS Instructions for Form 8824).
Full deferral generally means reinvesting all of the net proceeds and replacing the debt you are relieved of, with new debt or added cash.
The replacement property generally takes over the basis of the property you gave up, adjusted for boot and any gain recognized (IRC §1031(d)). That carryover basis shapes future depreciation, so factor it in before ordering a cost segregation study on the new property.
Reporting on Form 8824
Each exchange is reported on Form 8824. Exchanges with related parties, such as family members or related entities, carry a two-year holding rule, and Form 8824 is also filed for the two years after the exchange year (IRC §1031(f); IRS Instructions for Form 8824).
California’s clawback: FTB 3840
When you exchange California real property for property outside California, California keeps its claim to the gain. The Franchise Tax Board says the source of the gain is set when it is realized and is preserved no matter when it is recognized (FTB 3840 instructions). When you later sell the replacement property in a taxable transaction, the California-source gain is generally reported to California.
California requires an annual information return, Form FTB 3840 (R&TC §18032; §24953 for corporations):
- Who files. Individuals and entities alike, regardless of residence. For a disregarded entity, the owner files.
- How long. For the exchange year and each later year until the California-source deferred gain is recognized. Moving out of California does not end it, and FTB 3840 is filed on its own if you have no other California filing requirement.
- Later exchanges. Exchanging the out-of-state property again does not end the requirement (FTB, Reporting like-kind exchanges).
- If you do not file. If you file neither FTB 3840 nor a required California return, the FTB may estimate your income, including the deferred gain, and propose an assessment of tax, penalties, and interest (R&TC §18032).
California withholding and Form 593
California generally requires withholding when California real estate is sold, by default 3 1/3 percent of the sales price, with an alternative calculation based on estimated gain (R&TC §18662; FTB Form 593 instructions).
For an exchange, the seller certifies the exchange on Form 593 (FTB Form 593 instructions):
- At the initial sale. A deferred exchange is exempt from withholding when the relinquished property closes.
- If you receive boot. If you receive more than $1,500 in cash or other property from the sale, the intermediary generally must withhold.
- If the exchange fails. The intermediary generally must withhold 3 1/3 percent of the sales price, unless the alternative calculation is elected.
Planning points before you sell
- Start before the sale closes. The intermediary generally needs to be in place before the relinquished property transfers, so the proceeds never reach you (Treas. Reg. §1.1031(k)-1(g)(4)).
- Coordinate escrow, the intermediary, and your tax advisor. Closing statements, Form 593, and the exchange agreement should tell the same story.
- Calendar both deadlines on day one, including any return due date that cuts the 180 days short.
- Keep the paperwork for as long as the deferred gain lasts. The exchange agreement, identification notice, closing statements, and Form 8824 support your carryover basis and every FTB 3840 that follows.
How TreeStar can help
We help California property owners plan the tax side of an exchange before the sale closes, coordinate with the intermediary and escrow on timing and reporting, and prepare Form 8824 and the annual FTB 3840 filings that follow. TreeStar does not act as a qualified intermediary, and contract or title questions belong with your attorney. Our tax planning work can help you see the numbers first.
This article is general information, not advice for your situation. Rules change; confirm current law before acting.
