Federal law allows cross-state exchanges
A 1031 exchange does not have a geographic restriction at the federal level. You can sell a rental property in California, complete a like-kind exchange, and acquire a replacement property in Texas, Florida, or any other state. The exchange defers federal capital gains tax and depreciation recapture regardless of where either property is located.
The exchange follows standard rules: 45-day identification, 180-day closing, use of a qualified intermediary, and like-kind property. The state where the relinquished property was located may impose state taxes on the gain — and this is where cross-state exchanges get complicated.
State clawback provisions: the California problem
Several states have enacted clawback (also called follow-me or taint-and-trace) provisions for 1031 exchanges. California is the most prominent example. Under California law, when a California real property is exchanged for out-of-state replacement property, California defers the gain for the exchange year — but requires the seller to report the California-source gain when the replacement property is eventually sold. California FTB Form 3840 must be filed annually until the replacement property is sold.
States with similar clawback provisions include Oregon, Montana, Arizona, Colorado, and Massachusetts, among others. The specific rules differ by state. Some require annual information returns; others only require reporting at the time of the final sale. If you are moving capital out of a high-tax state like California, consult a tax professional before the exchange about how much California gain will eventually be due — even decades later.
State taxes in the year of exchange
Fourteen or so states do not conform to federal 1031 exchange rules or have partial non-conformity. This means the state in which your relinquished property is located may tax the gain in the year of the exchange even though the federal tax is deferred. Check the conformity status of your relinquished-property state before assuming the exchange defers both federal and state taxes.
The state where the replacement property is located will tax the eventual sale of that property under its own capital gains rules. If you are moving from a high-tax state to a no-income-tax state (like Texas or Florida), you may eliminate state income tax on future appreciation — but you will not escape the clawback on gains that originated in the prior state.
How California's clawback and Form 3840 work in practice
California's clawback is administered through FTB Form 3840. In the year you exchange California property for out-of-state replacement property and defer the California gain, you file Form 3840 with your California return. You must then continue filing Form 3840 every year — even if you owe no other California tax and file no other California return — as an information report that keeps the deferred California-source gain on the state's radar.
The filing obligation ends when you (a) sell the replacement property in a taxable transaction and report the California-source gain, (b) exchange again and continue tracking on a new Form 3840, or (c) the property transfers at death. Missing the annual Form 3840 can let the FTB estimate and assess the deferred gain plus penalties. Because the deferred gain can be pulled back decades later, keep the exchange records and file the form faithfully.
A worked example: California to Texas, then an eventual sale
You sell a Los Angeles rental with a $300,000 deferred gain and exchange into a Dallas rental. In the exchange year, no federal or California tax is due; you file federal Form 8824 and California Form 3840. Years later you sell the Dallas property outright for a total gain of $500,000 — the $300,000 of old California gain plus $200,000 of new Texas appreciation.
Texas has no state income tax, so Texas takes nothing. But California's clawback reaches the $300,000 of California-source gain that originated in the Los Angeles property — you owe California tax (up to 13.3% at the top rate) on that portion when you finally sell, even though you are now a Texas resident and the property sits in Texas. The $200,000 of Texas-sourced appreciation escapes California tax. Moving to a no-tax state removes state tax on future appreciation, not on the gain that accrued while the property was in California.
States that tax the gain in the exchange year
Most states conform to Section 1031 and defer the state tax along with the federal tax, but conformity is not universal and changes over time. Pennsylvania, for example, historically did not recognize 1031 deferral for its personal income tax and taxed the gain in the year of exchange; it conformed to Section 1031 only for exchanges in tax years beginning after December 31, 2022. Always confirm the current conformity status of the state where your relinquished property sits before assuming a full deferral.
If your relinquished-property state does not conform, you may owe state tax on the gain in the year of the exchange even though federal tax is deferred — an unwelcome surprise that can require cash you did not plan to spend. Check both the origin state (which taxes the built-in gain) and the replacement state (which taxes future appreciation) so you understand the full multi-state picture.
Nonresident withholding at the sale
Several states require the buyer or escrow to withhold a percentage of the sale price when the seller is a nonresident, to secure the state's tax. California withholds 3.33% of the sales price (or an optional gain-based amount) on real estate sales, and Colorado, Oregon, Maryland, and others have similar regimes. A properly structured 1031 exchange is generally exempt from this withholding — you certify the exchange to the escrow (in California, on Form 593) so no tax is withheld from proceeds that must flow to your qualified intermediary.
If you fail to certify the exchange, the withholding can strip cash out of the exchange funds, potentially creating boot and a partial failure of the exchange. Make sure your QI and escrow officer complete the correct nonresident-withholding exemption forms at the closing of the relinquished property.
Filing in multiple states and claiming resident credits
When you ultimately sell the replacement property — or when a non-conforming origin state taxes the exchange — you may have to file a nonresident return in the state where the gain is sourced and a resident return in your home state. Your resident state usually grants a credit for taxes paid to another state, preventing full double taxation — but the credit is limited to your home state's rate on the same income, so if the source state's rate is higher, you bear the difference.
For a clawback state like California, this means filing a California nonresident return reporting the California-source deferred gain in the year you finally recognize it, even years after you leave the state. Track the original California gain figure carefully — the FTB will expect the number reported on your old Form 3840 filings to match what you finally report.
Planning tips for moving capital across state lines
Before exchanging out of a high-tax state, quantify the eventual clawback so it does not surprise you a decade later, and keep every Form 3840 and exchange document in a permanent file. Consider whether your long-term plan is to hold until death — a basis step-up can eliminate the deferred gain, clawback included — or to keep exchanging, which perpetuates the deferral.
If you are relocating personally, understand that changing your residency does not change the source of gain that accrued in the old state. Coordinate the exchange with both a federal 1031 specialist and a state tax adviser familiar with the origin state's conformity and clawback rules, ideally before you list the relinquished property.
Entity ownership adds a state-sourcing wrinkle
If you hold the property through a partnership, LLC, or S-corp, the state-source character of the gain still generally follows the location of the real estate, and clawback obligations pass through to the members or shareholders. An out-of-state member of an LLC that sells California property, or that exchanged California property under the clawback, can be pulled into California filing and Form 3840 tracking through the entity. Some states also require the entity to withhold on nonresident members' shares of the gain, and to file a composite or nonresident return on their behalf.
Confirm how your state treats pass-through entity gains before assuming that holding title in an LLC changes the multi-state result — usually it does not change the sourcing, only who files and withholds. This is one more reason to bring a state tax adviser into the planning early, especially when the members live in different states from the property.
Frequently asked questions
Can I do a 1031 exchange from California to Texas?
Yes. Federal law allows cross-state 1031 exchanges. California will defer the state tax but may require annual Form 3840 filings and will clawback the deferred California gain when the Texas property is eventually sold.
Which states have 1031 exchange clawback provisions?
California, Oregon, Montana, Arizona, Colorado, and Massachusetts are among the states with clawback provisions, though the rules differ. Consult a state tax professional for your specific situation.
Does a cross-state 1031 exchange eliminate state taxes?
No. It defers state taxes in states that conform to federal 1031 rules. States with clawback provisions follow the deferred gain to the replacement property and collect when you sell.
How long do I have to file California Form 3840?
Every year after a California-to-out-of-state exchange until you sell the replacement property in a taxable transaction (or the property transfers at death). It is an annual information return that keeps the deferred California gain tracked; missing it can let the FTB assess the gain plus penalties.
Does moving to a no-income-tax state eliminate the clawback?
No. Clawback states like California tax the gain that accrued while the property was in that state, regardless of where you later live. Only appreciation sourced to the new state escapes the old state's tax.
Is a 1031 exchange exempt from nonresident withholding?
Generally yes, if you certify the exchange to escrow on the state's form (Form 593 in California). Without the certification, the state may withhold from proceeds that need to reach your qualified intermediary, which can create taxable boot.
Sources
- IRS — Like-Kind Exchanges (Real Estate Tax Tips)
- IRS — About Form 8824
- IRS Publication 527 — Residential Rental Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.