A 1031 exchange allows Los Angeles property owners to defer capital gains taxes by selling an investment property and reinvesting the proceeds into another like-kind property within 180 days. California requires annual FTB 3840 filing when exchanging California property for out-of-state real estate, and the state's "claw-back" provision means those deferred taxes eventually come due. This guide covers the essential rules, California-specific requirements, and practical steps for LA investors.
Key Takeaways
- 45-day identification deadline — No extensions, no exceptions
- 180-day completion window — Or your tax filing deadline, whichever comes first
- California tracks deferred gains — FTB 3840 required annually for out-of-state exchanges
- Qualified Intermediary required — Must be engaged before closing on your sale
- Same taxpayer rule — Entity selling must be entity buying
What Makes 1031 Exchanges Valuable for LA Property Owners
Los Angeles real estate has appreciated dramatically over the past decade. Many property owners who purchased investment properties years ago now face substantial capital gains when selling. A 1031 exchange, named after Section 1031 of the Internal Revenue Code, offers a legal path to defer those taxes by reinvesting proceeds into replacement property.
The math is straightforward. If you purchased a rental property in Silver Lake for $400,000 in 2010 and it's now worth $1.2 million, you're looking at $800,000 in potential capital gains. Combined federal and California state taxes could consume $200,000 or more of that gain. A 1031 exchange lets you reinvest the full amount, keeping your capital working.
This isn't tax elimination—it's tax deferral. The deferred gain carries forward to your replacement property. However, many investors use sequential exchanges throughout their careers, potentially deferring gains until death, when the stepped-up basis rules can eliminate the deferred tax entirely for heirs.
Essential Rules Every LA Investor Must Follow
The IRS imposes strict requirements that disqualify your exchange if violated. Understanding these rules before starting the process is critical.
The 45-Day Identification Period: After closing on your relinquished property (the one you're selling), you have exactly 45 calendar days to identify potential replacement properties in writing. This deadline is absolute—there are no extensions for holidays, weekends, or market conditions. Most investors identify two or three properties to provide backup options.
The 180-Day Exchange Period: You must close on your replacement property within 180 days of selling your original property, or by your tax filing deadline (including extensions), whichever comes first. In a competitive Los Angeles market where escrow periods can extend 30-60 days, starting your property search before listing your current property often makes sense.
Like-Kind Property Requirement: The replacement property must be held for investment or business use. You can exchange an apartment building for raw land, a retail center for industrial property, or a single-family rental for a multifamily complex. Personal residences and properties held primarily for resale (fix-and-flip) don't qualify.
Equal or Greater Value: To defer 100% of your capital gain, the replacement property must have equal or greater value than what you sold. If you trade down, you'll recognize gain on the difference, known as "boot." Reducing your mortgage debt also triggers boot unless offset by additional investment.
Same Taxpayer Rule: The person or entity selling the relinquished property must be the same one acquiring the replacement. If your property is in an LLC, the LLC must purchase the replacement. Individual ownership cannot swap to entity ownership mid-exchange without careful planning.
Why Qualified Intermediaries Are Non-Negotiable
You cannot touch the sale proceeds and still qualify for tax deferral. The IRS requires a qualified intermediary (QI) to hold your funds between sale and purchase. This isn't optional—it's the mechanism that makes the exchange work.
A qualified intermediary is a third party who receives your sale proceeds at closing, holds them during your identification and acquisition period, and then uses those funds to purchase your replacement property. You never have constructive receipt of the money, which preserves the exchange treatment.
Choosing your QI carefully matters. They should carry substantial errors and omissions insurance, maintain segregated accounts (not commingled funds), and have experience with California exchanges specifically. The QI must be engaged before you close on your relinquished property—not after.
QI fees typically range from $750 to $1,500 for standard delayed exchanges. More complex structures like reverse exchanges or build-to-suit arrangements cost more but offer additional flexibility when you need to acquire before selling or make improvements to your replacement property.
California's Unique Requirements: FTB 3840 and the Claw-Back
California adds complexity that other states don't impose. If you exchange California real estate for property located outside California, the Franchise Tax Board requires annual reporting through Form FTB 3840 until you sell the replacement property or conduct another exchange.
This filing requirement applies regardless of where you live. Former California residents who moved to Nevada or Texas years ago still file FTB 3840 annually if they exchanged California property for out-of-state real estate. The state tracks deferred California-source gains indefinitely.
California's "claw-back" provision means the state will collect its portion of deferred taxes when you eventually sell. Even if you exchange a Los Angeles property for one in a no-income-tax state, California still gets paid when the chain of exchanges ends. This doesn't make 1031 exchanges inadvisable—it just requires long-term tax planning.
For individuals filing joint returns with adjusted gross income under $500,000 (or $250,000 for other filers), California still allows like-kind exchanges for certain personal property, though the Tax Cuts and Jobs Act eliminated this at the federal level for exchanges initiated after January 10, 2019.
Common 1031 Exchange Structures for LA Investors
Different exchange structures suit different investment situations. Understanding your options helps you choose the right approach for your circumstances.
| Exchange Type | Best For | Timeline Pressure | Relative Cost |
|---|---|---|---|
| Delayed Exchange | Most investors; sell first, then buy | High (strict 45/180 days) | $750–$1,500 |
| Reverse Exchange | Buyers in competitive markets who find replacement first | Moderate (more flexibility) | $5,000–$15,000+ |
| Build-to-Suit | Investors wanting to improve replacement property | Very High (improvements must complete in 180 days) | $3,000–$10,000+ |
| Delaware Statutory Trust (DST) | Passive income seekers exiting active management | Moderate (pre-packaged investments) | Varies by sponsor |
Delayed Exchange: The most common structure. You sell first, then acquire replacement property within the timeline. Works well when you've identified opportunities in your target market before listing your current property.
Reverse Exchange: You acquire the replacement property before selling your current one. This requires parking the new property with an exchange accommodation titleholder (EAT) until your original property sells. Reverse exchanges cost more but eliminate the pressure of finding replacement property under deadline.
Build-to-Suit Exchange: Exchange proceeds fund improvements on replacement property. The improvements must be completed within the 180-day period. Useful when available properties don't meet your needs without renovation.
Delaware Statutory Trust (DST): For investors seeking passive income without management responsibilities, DST investments offer fractional ownership in institutional-quality properties. DSTs qualify as like-kind property and work well for investors who want to exit active property management while maintaining tax-deferred status.
Practical Steps for Your Los Angeles 1031 Exchange
Start planning before you list. Identify potential replacement properties, interview qualified intermediaries, and assemble your professional team. Rushing these decisions under the 45-day deadline leads to poor choices.
Build your team early. You'll need a qualified intermediary, a CPA familiar with California exchange requirements, potentially a real estate attorney for complex situations, and a real estate agent who understands investment property in your target market. Each professional should have 1031 experience—this isn't the time for generalists.
Document everything meticulously. The IRS and California FTB scrutinize exchanges. Keep records of property identification letters, exchange agreements, closing statements, and all communication with your QI. If audited, documentation determines whether your exchange qualifies.
Consider timing strategically. Los Angeles market conditions affect both your sale price and replacement property costs. Selling in a seller's market while buying in a buyer's market maximizes your exchange benefit. Your agent should help analyze market timing in both your current and target locations.
1031 Exchange Quick Reference Checklist
Before You Sell
- Property held for investment or business use (not personal residence)
- Qualified Intermediary selected and engaged
- Exchange agreement signed with QI before closing
- Potential replacement properties identified (research phase)
- CPA consulted on tax implications
Within 45 Days of Sale
- Replacement property(ies) identified in writing
- Identification delivered to QI before midnight on Day 45
- Maximum 3 properties identified (or 200% rule if more)
Within 180 Days of Sale
- Replacement property under contract
- QI funds purchase directly (you never touch proceeds)
- Closing completed before Day 180 or tax filing deadline
- Equal or greater value acquired (to avoid boot)
- Same taxpayer on both transactions
After Exchange Completes
- Form 8824 filed with federal tax return
- Form FTB 3840 filed if replacement is out-of-state
- All exchange documents retained (7+ years recommended)
- Basis tracking established for replacement property
Frequently Asked Questions
Can I use a 1031 exchange for my primary residence?
No. The property you sell and the property you acquire must both be held for investment or business use. Primary residences don't qualify. However, converting a rental property to a primary residence after an exchange—or vice versa—is possible with careful planning and holding period considerations.
What happens if I miss the 45-day identification deadline?
Your exchange fails, and you'll owe capital gains taxes on the entire gain from your sale. The deadline is absolute. No extensions exist for any reason. This is why working with experienced professionals and identifying properties before selling your current property reduces risk significantly.
Can I exchange a Los Angeles property for one in another state?
Yes. 1031 exchanges work across state lines. However, California requires annual FTB 3840 filing until you sell the out-of-state replacement property. The claw-back provision means California will collect its deferred tax when the chain of exchanges ends, regardless of where the final property is located.
Do I need to use all the proceeds to avoid taxes?
To defer 100% of your gain, you must reinvest all proceeds into replacement property of equal or greater value while maintaining or increasing your debt. Any cash received or debt reduction creates taxable "boot."
How long must I hold the replacement property?
The IRS has no specific holding period, but the property must be held for investment or business use, not immediate resale. Most tax professionals recommend a minimum one to two-year holding period to demonstrate investment intent. Properties exchanged with related parties have a two-year rule preventing disposition.
Can I do a 1031 exchange through my LLC or corporation?
Yes. The entity that owns the relinquished property must be the same entity acquiring the replacement property. Single-member LLCs are disregarded entities for tax purposes, so the member—not the LLC—is treated as the taxpayer for exchange purposes.
What is boot and how do I avoid it?
Boot is taxable non-like-kind property received in an exchange. Cash, debt relief, or personal property received creates boot. Avoid it by reinvesting all proceeds and either maintaining your debt level or adding additional investment to offset any mortgage reduction.
Are there limits on how many times I can do a 1031 exchange?
No statutory limit exists. Many successful real estate investors conduct sequential exchanges throughout their careers, potentially deferring gains indefinitely. Each exchange must independently satisfy all requirements.
What's the difference between a delayed and reverse exchange?
In a delayed exchange, you sell your property first, then acquire replacement property within 180 days. In a reverse exchange, you acquire the replacement property first (parked with an accommodation titleholder), then sell your original property. Reverse exchanges offer more flexibility but cost significantly more.
Can I exchange into multiple properties?
Yes. You can exchange one property into multiple replacement properties, or consolidate multiple properties into one. The same rules apply: identify within 45 days, close within 180 days, and ensure total value equals or exceeds what you sold to fully defer gains.
Get Guidance on Your 1031 Exchange
Navigating a 1031 exchange in Los Angeles requires understanding both federal IRS rules and California's unique requirements. The tight deadlines, documentation requirements, and coordination between multiple professionals demand careful planning.
The Borges Real Estate Team works with investors throughout Los Angeles County who are considering 1031 exchanges as part of their investment strategy. We coordinate with qualified intermediaries and tax professionals to help ensure every deadline is met and every requirement addressed.
If you're considering a 1031 exchange or want to discuss whether it makes sense for your investment property, contact our team for a confidential consultation.
Important Notice: This article provides general information about 1031 exchanges and should not be construed as tax, legal, or financial advice. Tax laws are complex, vary by jurisdiction, and change frequently. The information provided reflects regulations as of December 2025 but may not reflect subsequent changes.
1031 exchange transactions involve strict IRS deadlines and documentation requirements. Errors can result in full taxation of capital gains. Before making any decisions regarding a 1031 exchange, consult with:
- A qualified tax professional or CPA familiar with IRC Section 1031
- A real estate attorney licensed in your jurisdiction
- A qualified intermediary with 1031 exchange experience
The Borges Real Estate Team provides real estate brokerage services and does not provide tax, legal, or financial advice.
