Sell a California rental property and face combined federal and state capital gains taxes exceeding 30%. On a $400,000 gain, that's $120,000+ to taxes.
A 1031 exchange defers 100% of it—if you follow the rules exactly.
What a 1031 exchange does
Section 1031 lets you sell investment property and buy replacement property without paying immediate taxes. Both federal capital gains (15-20%) and California taxes (up to 13.3%) get deferred.
Without 1031:
- Sell for $700K (gain $400K)
- Federal tax: $80K
- CA tax: $53K
- Net: $567K to reinvest
With 1031:
- Sell for $700K
- Tax: $0
- Full $700K reinvested
That's $133K staying in your portfolio.
Basic requirements
Like-kind property: Any real estate for any other real estate held for investment or business.
Valid exchanges:
- Rental house → apartment building
- California rental → Texas rental
- Retail space → vacant land
Doesn't qualify:
- Real estate → stocks
- Primary residence → rental (without waiting period)
- Properties held for quick resale
Equal or greater value: Buy replacement property worth at least as much as what you sold.
Debt replacement: Match or exceed your existing loan balance on the replacement property, or add cash.
Use a Qualified Intermediary (QI): Sale proceeds go to the QI, never to you. If funds hit your account, the exchange fails.
The 45-day and 180-day deadlines
45 days to identify
From your sale closing, you have 45 calendar days to identify up to 3 replacement properties in writing to your QI.
Get Your Free Rate Quote
See current rates and get a personalized quote in minutes. No credit check required.
CA DRE #01212512 | Free, no-obligation quote
- Be specific: addresses and legal descriptions required
- No extensions—weekends and holidays count
- Miss this deadline = exchange fails
In competitive California markets, start shopping before you list.
180 days to close
Close on your replacement property within 180 days of your sale (or your tax return due date if earlier).
Example:
- Sell: January 15
- Identify by: March 1 (45 days)
- Close by: July 14 (180 days)
Miss either deadline and you owe full taxes immediately.
Qualified Intermediary selection
You cannot do this yourself. You need a QI to:
- Hold your sale proceeds
- Prepare exchange documents
- Wire funds to replacement property closing
Choose a QI with:
- Fidelity bond insurance
- Segregated client accounts
- Years of experience
If your QI goes bankrupt, you lose your money AND the tax deferral.
Cost: $800-$1,500 typically.
Types of 1031 exchanges
Delayed exchange (most common): Sell first, buy replacement within 180 days.
Reverse exchange: Buy replacement first, then sell. Complex and expensive ($10K-$25K in fees), but useful when you find the perfect property before selling.
Improvement exchange: Buy property and improve it using 1031 proceeds. All construction must finish within 180 days.
California tax deferral
California taxes capital gains as ordinary income—up to 13.3%. When you defer federal taxes via 1031, California taxes defer automatically.
But: California residents who exchange into out-of-state property will owe California tax on the eventual sale unless they change residency before that final sale.
Boot creates taxable income
"Boot" is any value you don't reinvest:
Cash boot: Take $40K from proceeds → $40K taxable
Mortgage boot: Replace $350K loan with $250K loan → $100K taxable difference
To avoid boot, reinvest everything and match your debt.
How to execute a 1031
1. Hire your QI before listing — Have exchange documents ready for your sale closing.
2. Include 1031 language in sale contract — Notify buyer you're doing an exchange.
3. Sale closing — Proceeds wire directly to QI.
4. Identify within 45 days — Submit written list of up to 3 properties to QI.
5. Purchase replacement property — QI wires funds to your replacement property closing.
6. File Form 8824 — Report the exchange on your tax return.
Common mistakes that kill exchanges
Missing the 45-day deadline: California inventory moves fast. Start your search early.
Touching the proceeds: Never receive sale funds directly. Let your QI handle everything.
Insufficient debt replacement: Your new loan must equal or exceed your old loan, or you add cash.
Related party exchanges: Exchanging with family often gets challenged by IRS.
Converting to personal use too quickly: Rent for 1-2 years before converting to your primary home.
Financing replacement properties
You can finance your replacement property. Key rule: new debt must equal or exceed old debt to avoid mortgage boot.
Example:
You Might Also Like
- →
5 Ways to Finance Rental Properties in California
Rental property financing options: conventional, DSCR, portfolio loans, hard money, and HELOC strategies. Pros, cons, and when to use each.
- →
Multifamily Investing California: 2-4 Unit Financing Guide
California multifamily (2-4 unit) property financing: conventional vs DSCR, qualification, rates, and best strategies for investors.
- Old loan: $250K
- New loan: $300K
- Result: No boot ✓
Bad example:
- Old loan: $250K
- New loan: $150K
- Result: $100K mortgage boot (taxable) ✗
For investment property financing, work with lenders who understand 1031 timing pressure.
Partial 1031 exchanges
You can take some cash and defer tax on the rest:
Example:
- Sell for $650K
- Take $100K cash (pay tax on this)
- Reinvest $550K (defer tax on this)
Useful when you need liquidity but want to defer most of the gain.
Advanced: Chaining 1031 exchanges
You can do unlimited consecutive 1031 exchanges, deferring taxes for decades.
Better: when you die, heirs inherit with stepped-up basis. Deferred taxes disappear completely.
When to skip the 1031
Pay the tax if you're:
- Exiting real estate entirely
- Need immediate liquidity
- Can't find suitable replacement property
- Have minimal gains
Don't force a bad investment just to defer taxes.
Real example: Fresno to Bakersfield
Investor:
- Sells duplex for $550K (basis $200K, gain $350K)
- Buys fourplex for $650K
- Uses $550K from exchange + $100K cash
- Gets new $400K loan
Tax deferred: $105K+ (federal + California combined)
That $105K stays invested instead of going to tax authorities.
FAQs
Can I exchange California property for out-of-state property?
Yes, but California residents will owe state tax on eventual sale unless they move first.
How many 1031s can I do?
Unlimited.
Can I 1031 into a Delaware Statutory Trust?
Yes. DSTs qualify for fractional ownership.
What if I die with deferred gains?
Your heirs inherit with stepped-up basis. Deferred taxes disappear.
Ready to discuss 1031 exchange financing? Get A Quote.
LoanAll.com (operated by LoanAll.com)
CA DRE #01212512 | NMLS #2787839
Bill McCoy | 888-421-1117 | info@loanall.com