Are 1031 Exchanges in California at Risk in 2026 and Should You Do One Now?
Justin Borges, DRE #01940318 · 12 min read · Updated August 2026
If you own investment property in Los Angeles, Pasadena, Glendale, or anywhere in the greater metro, you have probably heard versions of the same question from other investors: is this the last chance to do a 1031 before Congress kills it? The anxiety is real, even if the immediate threat has passed.
The 2021 Build Back Better proposal would have capped the deferral at $500,000 per year per taxpayer. It passed the House and then stalled in the Senate. A version of the concern surfaced again during 2025 budget negotiations. But the final One Big Beautiful Bill Act, signed into law on July 4, 2025, left Section 1031 of the Internal Revenue Code completely untouched, per the IPX1031 Tax Reform Update published July 2025. No cap. No phase-out.
So the federal threat did not materialize this cycle. But California investors have two state-level complications that do apply: a new 2026 law restricting corporate buyers from using 1031 exchanges on single-family homes, and the California clawback rule under Revenue and Taxation Code Section 18032, which has been in place since 2014 and quietly surprises investors who move their equity out of state.
This guide answers the exact questions you are asking: how the rules work now, what the numbers look like on a real LA property, who the new California law actually affects, and whether timing your exchange to 2026 makes sense given what is known.
What Is Covered in This Guide
How a 1031 Exchange Works in California
IRC Section 1031 allows an investor to sell an investment or business property and defer all capital gains taxes, federal and state, by rolling the proceeds into a like-kind replacement property. California conforms to the federal 1031 rules, which means a properly structured exchange defers both your federal and California state capital gains in the same transaction.
The mechanics require a Qualified Intermediary (QI): an independent third party who holds your sale proceeds after closing and uses them to fund the replacement property purchase. You cannot receive or control the funds at any point. Once you or your attorney takes custody of the money, the exchange is disqualified and the full gain is taxable in the year of sale.
"The most common mistake I see is an investor who finds out about 1031 exchanges after closing. You have to set this up before you sign the closing papers on the property you are selling."
Justin Borges, DRE #01940318Only investment and business property qualifies. Your primary residence does not. A vacation home you rent out part-time may qualify depending on how it is used. If you rented out a former primary residence for at least a year before selling, it may qualify as an investment property, but this is a determination to make with a CPA, not an assumption.
Like-kind under federal law is broad for real property. An apartment building can be exchanged for a retail strip center. A raw land parcel can be exchanged for a multifamily building. The requirement is that both properties are real property held for investment. For a deeper look at the basics, see our complete guide to what a 1031 exchange is for Los Angeles investors.
One rule applies to the entire structure: no boot. Boot is any amount of the sale proceeds that is not reinvested. If you sell for $2,000,000 and only reinvest $1,800,000 into the replacement, the $200,000 difference is taxable immediately. To defer the entire gain, the replacement property value must equal or exceed the relinquished property value, and all net equity must be reinvested.
Thinking About a 1031 Exchange Before the Rules Change?
The window may be narrowing. Investors who initiate their 1031 exchange before a legislative change is finalized protect themselves. Text us and we will walk through your options and timeline.
Text Us Before You ListThe 45-Day and 180-Day Deadline Rules
Two hard deadlines govern every 1031 exchange. Both run from the date the relinquished property closes, not from the date you list replacement properties or the date you sign a purchase contract. For a full day-by-day breakdown of these windows, see the step-by-step 1031 exchange timeline published separately.
Relinquished property closes
The exchange clock starts. Your Qualified Intermediary receives the sale proceeds. Both deadlines are now running simultaneously.
Identification deadline (no exceptions)
Written notice of potential replacement properties must be submitted to your QI. The three-property rule allows up to 3 candidates regardless of value. The 200% rule allows more properties if their total value does not exceed twice the relinquished property value. Missing this deadline disqualifies the entire exchange. No extensions exist under any circumstances.
Close deadline (or tax return due date, whichever is earlier)
You must close on at least one of the identified replacement properties by Day 180, or by the due date of your tax return for the year of sale including extensions, whichever comes first. If Day 180 falls before your return due date, Day 180 controls. Missing this deadline is disqualifying with no cure.
The Identification Rules in Detail
You do not have to close on all identified properties. You only have to close on one to complete a valid exchange. The identification rules are:
- 3-Property Rule: Identify up to 3 properties of any value. Most investors use this rule.
- 200% Rule: Identify any number of properties if their combined fair market value does not exceed 200% of the relinquished property value.
- 95% Rule: Identify any number of properties of any combined value, provided you close on properties representing at least 95% of the total identified value. This rule is rarely practical.
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View Investment ListingsWhat Congress Proposed and What Actually Passed
The concern about 1031 exchanges being eliminated or capped traces directly to the 2021 Build Back Better Act. President Biden's proposal would have limited the annual deferral under Section 1031 to $500,000 per taxpayer. The House passed a version of the legislation in November 2021. The Senate never brought it to a vote, and the provision died with the bill.
The $500,000 cap proposal surfaced again in various 2023 and 2024 budget discussions, and investor anxiety picked up again as the One Big Beautiful Bill Act moved through Congress in 2025. The final law, signed July 4, 2025, preserved Section 1031 in full. Per reporting from IPX1031 and NEREJ, no dollar cap, no annual limit, and no phase-out for high-value exchanges were included in the enacted legislation.
Should You Worry About Future Congressional Risk?
The honest answer is that the risk has not permanently disappeared. It was removed for this legislative cycle, but budget negotiations return on a predictable schedule, and 1031 exchanges represent a large pool of deferred tax revenue that Congress periodically eyes. The Joint Committee on Taxation has estimated the 10-year cost of the 1031 provision at over $40 billion, which makes it a target in deficit-reduction conversations.
What this means practically: the uncertainty that drove investor urgency in 2021 and 2025 is likely to resurface. If you have a property with a large gain and a logical replacement already identified, waiting to see whether Congress revisits the question in the next budget cycle is a risk. If you are not yet ready to exchange, forcing a transaction to beat a perceived deadline that may or may not materialize is also a risk.
For a structured framework for making this decision, see the 1031 exchange evaluation framework that walks through the actual decision variables.
"Every time there's a federal budget negotiation, someone puts 1031 on the table. The pattern going back to the Obama years is that it gets discussed and doesn't move. But each cycle that doesn't happen is not a guarantee about the next one."
Justin Borges, DRE #01940318California's Two Specific 1031 Complications
California conforms to federal 1031 rules, meaning an exchange properly structured under IRC Section 1031 defers both federal and California capital gains. But California has two provisions that create risk or complexity beyond the federal rules. Both require understanding before you structure an exchange involving California property.
Complication 1: The California Clawback Rule (R&TC Section 18032)
If you exchange a California investment property for a replacement property located in another state, California considers the deferred gain to remain its tax revenue indefinitely. Under California Revenue and Taxation Code Section 18032, added by AB 92 in 2013 and effective for tax years beginning January 1, 2014, you must file Form 3840 with the Franchise Tax Board every year, starting with the year of the exchange, until the replacement property is eventually sold in a taxable event.
When you sell the out-of-state replacement property, California taxes the originally deferred gain, regardless of whether you are still a California resident at that time. Moving to Nevada or Texas between the exchange and the eventual sale of the replacement property does not extinguish California's claim on the gain.
This does not mean you cannot do an out-of-state exchange. Many California investors move equity from low-yielding Los Angeles properties into higher-cash-flow markets in Phoenix, Las Vegas, or Austin using a 1031 exchange, knowing that California will eventually collect its deferred taxes. The strategy makes sense when the replacement property's cash flow, appreciation potential, or other factors outweigh the future California liability. What it does mean is that the clawback obligation must be factored into your exit projections for the replacement property.
Source: California Franchise Tax Board / exeterco.com / apiexchange.com analysis of AB 92.
Complication 2: AB 1611 (Effective January 1, 2026)
California AB 1611, signed in 2025 and effective January 1, 2026, bars corporations that directly or indirectly own more than 50 single-family homes from using 1031 exchanges on those single-family properties. The law is aimed at large institutional landlords and targets an estimated 110,000 single-family homes statewide owned by corporate entities holding 50 or more properties, according to the bill's legislative analysis.
The impact on most investors reading this article is zero. Individual investors, family trusts, and small LLCs owning any number of properties below the 50-single-family-home threshold in a single entity are not affected by AB 1611. The law specifically targets the institutional corporate landlord category.
If you are an investor operating through multiple entities and your portfolio approaches or exceeds 50 single-family homes across related entities, you should get a legal analysis of whether the aggregation rules in AB 1611 could apply to your structure. Source: AB 1611 bill text from leginfo.legislature.ca.gov, Assemblymember Matt Haney's office press release, April 2026.
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Browse Multifamily ListingsThe Tax Math: What You Actually Owe Without a 1031
The numbers are the reason 1031 exchanges matter. California investors face one of the heaviest combined capital gains tax burdens in the country because the state taxes capital gains as ordinary income at rates up to 13.3%, on top of federal rates. For a high-income investor in 2026, the combined federal and state burden on a long-term real estate gain can reach 37.1% before accounting for depreciation recapture.
Federal long-term capital gains rates for 2026, per the current brackets:
- 0% for taxable income up to $49,450 single / $98,900 married filing jointly
- 15% for income up to $545,500 single / $613,700 married filing jointly
- 20% for income above those thresholds
The Net Investment Income Tax (NIIT), imposed under IRC Section 1411, adds 3.8% on top of the capital gains rate for taxpayers whose modified adjusted gross income exceeds $200,000 single or $250,000 married filing jointly. These NIIT thresholds are not adjusted for inflation and have not changed since the tax was enacted in 2013. Source: IRS Publication 550, 2026 edition; USTaxTools 2026 capital gains rate table.
California taxes capital gains as ordinary income. The top bracket is 13.3% for income above $1,000,000 (single filers). For most high-income investors in the LA market, capital gains from a multi-million dollar property sale will push total California income well into the top bracket. Source: California Franchise Tax Board 2026 rate schedules.
| Tax Component | Rate Applied | Without 1031 ($800K Gain) | With 1031 Exchange |
|---|---|---|---|
| Federal Long-Term Capital Gains | 20% | $160,000 | Deferred |
| Federal Net Investment Income Tax | 3.8% | $30,400 | Deferred |
| California Capital Gains (as ordinary income) | 13.3% | $106,400 | Deferred |
| Total Tax Due at Sale | 37.1% combined | $296,800 | $0 now |
Table assumes high-income California investor, MFJ income above $613,700 triggering the 20% federal LTCG rate, MAGI above $250K triggering NIIT, and California income above $1,000,000 triggering the 13.3% state rate. Depreciation recapture (taxed federally at up to 25%) is excluded; actual tax bill is higher for depreciated properties. Consult a CPA for your specific basis and rate situation. Source: IRS 2026 capital gains brackets; California FTB 2026 rates.
For context on how California's capital gains rules interact with real estate sales beyond 1031 exchanges, the California capital gains tax on home sales guide covers the full landscape including the Section 121 primary residence exclusion and Proposition 19 basis rules.
The $296,800 that stays in a 1031 exchange stays in the replacement property, compounding. That is the core argument for the strategy: the deferred tax functions as an interest-free loan from the federal and state governments, reinvested into the replacement asset for as long as you hold it.
What Is My Investment Property Worth in 2026?
Before you can plan a 1031 exchange, you need an accurate market value for your relinquished property. Get a free, comps-backed valuation specific to your LA area investment.
Get My Free Property ValuationShould You Do a 1031 Exchange in California Right Now?
The question is not whether 1031 exchanges work. They clearly defer large amounts of tax when used correctly. The question is whether your specific situation, property, and goals make a 1031 the right move in 2026, given the rules as they currently stand.
The evaluation framework below is not exhaustive, but it covers the factors that actually drive the decision for Los Angeles area investors. For the complete decision process with more scenarios, see the 1031 exchange evaluation framework.
Do the 1031: Strong Case
- You have a large taxable gain, above $200K, making the deferred tax material
- You have a replacement property type in mind before you close
- You plan to continue investing in real estate, not liquidate
- Your combined tax rate (federal plus California) is above 30%
- You want to trade up to a higher-value or better-cash-flow property
- You have a Qualified Intermediary engaged before the sale closes
- You are doing the exchange within California (clawback does not apply)
Consider Carefully First
- You are moving equity out of California into another state (clawback follows you)
- You have not yet identified any replacement property options
- You need the liquidity from the sale for another purpose
- Your gain is small enough that the tax is manageable
- You plan to hold the replacement property for less than 5 years
- You are a corporation that may approach 50 SFH under AB 1611
- You are planning to leave a property to heirs (step-up in basis at death may eliminate the deferred gain)
The step-up in basis point deserves a specific note. Under current law, when you die holding an investment property, your heirs receive the property with a basis stepped up to fair market value at your date of death. If you have been doing 1031 exchanges and accumulating deferred gain, that gain is potentially eliminated at your death through the step-up. This makes a 1031 exchange potentially even more attractive for investors who plan to hold through their estate, not sell before they die.
For most California investors, the decision comes down to: do I have a replacement property to exchange into? If the answer is yes and the gain is meaningful, the 1031 exchange is almost always the right call at today's rates. If the answer is no and you are selling speculatively to sit on cash while you figure out where to reinvest, the 45-day deadline will pressure you into a suboptimal replacement purchase.
1031 Exchange Decision Cheat Sheet
| If Your Situation Is... | Then... | Why |
|---|---|---|
| Selling a California rental with over $300K gain | Likely do the 1031 | Tax at risk exceeds $111K, making QI cost worthwhile |
| Exchanging CA property for another CA property | Standard exchange, no clawback concern | Clawback only applies if replacement is out of state |
| Moving equity from LA to Arizona or Nevada | Plan for clawback + annual Form 3840 | CA will tax the deferred gain when AZ property eventually sells |
| Planning to leave the property to children | 1031 now, step-up later | Step-up in basis at death may eliminate the accumulated deferred gain |
| Corporate entity owning 50+ CA single-family homes | Get legal review of AB 1611 applicability | AB 1611 effective January 1, 2026 bars 1031 for those entities on SFH sales |
| No replacement property identified yet | Line up options before closing | 45-day window is unforgiving in low-inventory LA markets |
Search for LA County investment properties to identify as 1031 replacements
Find Replacement Properties1031 Exchange in California: Common Questions
Are 1031 exchanges still legal in 2026?
Yes. The One Big Beautiful Bill Act, signed July 4, 2025, preserved IRC Section 1031 completely intact with no dollar cap and no deferral limit. The proposed $500,000 cap from the 2021 Build Back Better bill never became law. As of August 2026, full deferral remains available on exchanges of any size. Source: IPX1031 Tax Reform Updates, July 2025.
What is California's clawback rule on 1031 exchanges?
Under California Revenue and Taxation Code Section 18032, if you exchange a California property for a replacement property in another state, California tracks the deferred gain via annual Form 3840 filings with the FTB. When you eventually sell the out-of-state replacement property, California taxes the originally deferred gain even if you no longer live in California at that time.
Does California AB 1611 affect regular real estate investors?
No. AB 1611, effective January 1, 2026, bars only corporations that directly or indirectly own more than 50 single-family homes from using 1031 exchanges on those SFH properties. Individual investors, family LLCs, and any entity owning fewer than 50 single-family homes in a single structure are not affected. Multifamily exchanges are entirely outside the scope of AB 1611.
What happens if I miss the 45-day identification deadline?
The exchange is disqualified entirely. No extension exists for any reason, including market conditions, illness, escrow delays, or other hardships. The full taxable gain from the sale of the relinquished property becomes due in the year of sale. This deadline is the most consequential deadline in the entire 1031 process.
Can I use a 1031 exchange on my California primary residence?
No. IRC Section 1031 applies only to property held for investment or productive use in a trade or business. A primary residence does not qualify. If you previously rented your home and later moved in, or plan to convert a current rental to your residence, speak with a CPA about the timeline requirements before structuring any exchange.
How much tax does a 1031 exchange defer on an LA investment property?
On an $800,000 gain for a high-income California investor, a properly executed 1031 exchange defers approximately $296,800 in combined taxes: $160,000 in federal LTCG at 20%, $30,400 in NIIT at 3.8%, and $106,400 in California capital gains tax at 13.3%. Depreciation recapture on improvements is taxed separately at up to 25% federally and is also deferred. Source: IRS 2026 rate schedules; California FTB 2026 rates.
Is there still risk that 1031 exchanges could be eliminated in the future?
Yes. The federal legislative risk did not disappear permanently with the OBBBA. The $500,000 cap proposal has now surfaced in multiple congressional cycles, and the Joint Committee on Taxation has estimated the 10-year revenue cost of Section 1031 at over $40 billion. Future budget negotiations can and likely will revisit this. The 2025 OBBBA provides clarity for the current period, but investors with large gains and ready replacement properties should not assume perpetual protection.
Planning a 1031 Exchange in California?
The rules may be changing. If you are considering a 1031 exchange, the time to start planning is before legislation is finalized — not after.
- Free property valuation to determine your exchange equity
- Timeline strategy: when to list to meet the 45-day identification window
- Text us before you list — the exchange clock starts on closing day
