1031 Exchange & DST Investing in California
California conforms to Section 1031 but has the nation's highest top income tax rate at 13.3% and enforces a clawback through the annual FTB 3840 filing when owners exchange into out-of-state property. Its large, high-value markets make it the single biggest source of 1031 replacement capital in the country.
State tax treatment of a 1031 exchange
California conforms to Section 1031 for real property, so a properly structured exchange defers California tax on the gain. California taxes capital gains as ordinary income, with a top marginal rate of 13.3% (including the 1% mental health services surtax on income above $1 million). Sellers are generally subject to 3.33% withholding of the sales price under Form 593, with an exemption available when the transaction qualifies as a 1031 exchange.
California is a clawback state. When a California property is exchanged for replacement property outside California, the taxpayer must file Form FTB 3840 for the year of the exchange and annually thereafter, until the deferred California-source gain is recognized. Failure to file can allow the Franchise Tax Board to assess the deferred gain.
Market snapshot
California's investment markets span Los Angeles, the San Francisco Bay Area, San Diego, Orange County, and Sacramento, and rank among the largest and most liquid in the nation. Multifamily, industrial and logistics, and life-science and R&D space dominate institutional demand, alongside significant net-lease and mixed-use activity.
High property values, established rent-control and tenant-protection regimes, and elevated operating costs make California a heavy exporter of exchange capital, as owners of appreciated real estate seek to defer large gains and reduce active-management burdens.
Why 1031 & DST investors look here
- Highest deferred gains in the country, given a 13.3% top rate and high values
- Deep, liquid markets in Los Angeles, the Bay Area, and San Diego
- Owners seeking relief from rent regulation and active management
Replacement-property options
Replacement property does not have to be in California — like-kind real estate is nationwide, and many California exchangers deliberately move capital into lower-cost, higher-yield out-of-state markets. DSTs, 721 UPREIT structures, and Opportunity Zone investments let California owners exchange into passive, professionally managed assets; when the replacement is outside California, the annual FTB 3840 filing keeps the deferred California gain properly reported.
Frequently asked questions
Does California tax a 1031 exchange?
California conforms to Section 1031, so a valid exchange defers California tax on the gain; the deferred gain is taxed at up to 13.3% when eventually recognized.
Can I exchange California property for out-of-state DSTs?
Yes, but California's clawback rule requires you to file Form FTB 3840 for the exchange year and each year after, until the deferred California-source gain is recognized.
What is the FTB 3840 filing?
FTB 3840 is California's annual information return tracking gain deferred in a 1031 exchange into property outside California, preserving the state's ability to tax that gain when it is later recognized.
Gerald F. “Jerry” Baker, III — Founder & Managing Principal, Baker 1031 Investments · FINRA Series 22 / 63 · SIE. Read full bio →
State tax treatment is general and changes frequently; this page is educational and is not tax, legal, or investment advice. Confirm current state and local rules with your own CPA and attorney. Securities offered through Aurora Securities, member FINRA/SIPC. Real estate investments involve risk, including possible loss of principal.