1031 out of California: does the state still tax the gain?

An educational overview, not advice. Read the disclosures. They matter.

The short answer

California requires an annual FTB Form 3840 filing when California property is exchanged for out-of-state property. If you exchanged California property for out-of-state property, that filing generally applies to you every year until the deferred gain is recognized, whether or not anyone mentioned it at closing.

California treats the gain deferred in an exchange of California property for out-of-state property as California-source income, and requires FTB Form 3840 to be filed every year, regardless of residence, generally until that gain is recognized. (Source: FTB 2025 Form 3840 Instructions.)

What that means for the tax on your own later sale depends on your facts. That is a question for your CPA, with your exchange paperwork in hand.

Why the exchange feels like an exit

You sell a rental in Orange County, buy an apartment building in Nevada or Arizona, and the tax bill you were braced for does not arrive. Some owners move out of the state in the same stretch.

A 1031 exchange defers gain; it does not eliminate it. And when the property you gave up was in California and the one you bought is not, California treats the deferred gain as California-source income and requires FTB Form 3840 to be filed every year, regardless of residence, generally until that gain is recognized.

The filing that is easy to forget

The filing is annual. It is a small chore attached to a transaction you finished years ago, and nothing about owning the new building reminds you of it, which makes it easy to miss.

If you have already exchanged out of California and have never heard of this form, that is the sentence in this article worth acting on. Ask your CPA whether your exchange should have been reported, and how to handle any year that was missed.

A question to settle before it reaches your heirs

An owner exchanges a California rental into an out-of-state building, files Form 3840 for a few years, then stops, or never starts. Years later the owner dies, and the children inherit a building in another state with no obvious California connection at all.

What the deferred gain and the Form 3840 filings mean for the people who inherit the property is a question for a CPA looking at the actual filings, not a web page. What we can tell you plainly is that the question exists and is worth asking before the property is listed.

If you are the person who did the original exchange, leave a file with the exchange documents and the Form 3840 filings in it, and tell your family it is there.

The exchange itself has risks

If you are still deciding whether to exchange out of California, the Form 3840 filing is not the only thing to weigh.

The deadlines are strict. Replacement property must be identified within 45 days of the sale, and the exchange must close within 180 days. Property identified or received outside those deadlines is treated as property that is not like-kind, and gain on the sale can then be taxed.
The replacement property carries its own investment risks.
Cash you take out is taxable. If the exchange otherwise qualifies, the gain taxed is capped at the amount of cash you take out, and it is taxed in the year of the sale.
The deferral ends when the chain ends. A 1031 exchange defers gain; it does not eliminate it. The deferred gain is taxed when you later sell in a taxable sale, and depreciation recapture can come due then as well.

What to do about it

If you are considering an exchange out of California, ask your CPA, before you choose the replacement, what the Form 3840 filing will involve and how California treats the deferred gain if you later sell.

If you have already exchanged and are filing Form 3840, keep filing, and keep the paperwork somewhere your family would find it.

If you have already exchanged and have not been filing, talk to a CPA.

If you are about to sell the replacement property, ask your CPA how your Form 3840 history bears on the sale before you sign anything.

If you moved out of California and exchanged to property out of California, don't come to the immediate conclusion that you are "safe" from California tax. The FTB (Franchise Tax Board) is widely considered the best collection agency in the world, and at least one tax firm reports that its residency audits of people who say they have moved away are rising. (Source: Wilson Tax Law, "CA Residency Audits Are Surging," November 2025.) Also, if you didn't know, some are contending California is approaching a credit crisis. In November 2025 the Legislative Analyst's Office projected an $18 billion budget problem for 2026-27 and structural deficits of about $35 billion a year from 2027-28, and the Equable Institute put California's public pension systems about $264 billion short of full funding in 2025. (Sources: Legislative Analyst's Office, "The 2026-27 Budget: California's Fiscal Outlook," November 19, 2025; Equable Institute, California pension funding, 2025.)

Frequently asked

Do I have to file Form 3840 every year, or only in the year of the exchange? California requires an annual Form 3840 filing when California property is exchanged for out-of-state property. How many years that runs for your exchange is a question for your CPA.

Is this the same as Proposition 19? No. Prop 19 changed California's parent-child (intergenerational) exclusion rules for property-tax reassessment. Form 3840 is the Franchise Tax Board filing for an exchange of California property into out-of-state property.

Estate Planning disclosure. Material prepared herein has been created for informational purposes only and should not be considered investment, tax, or legal advice or a recommendation. Information was obtained from sources believed to be reliable but was not verified for accuracy.

Estate planning involves complex legal and tax considerations that vary significantly based on individual circumstances and the laws of the applicable jurisdiction. Federal and state estate, gift, and generation-skipping transfer tax laws under the Internal Revenue Code (IRC) and applicable state statutes are subject to change, including scheduled sunset provisions that may alter exemption amounts and tax rates. The strategies discussed may not be suitable for all individuals, and their effectiveness depends on factors unique to each person's situation. Savvy Advisors Inc. does not provide legal advice or prepare legal documents. It is the responsibility of individuals to verify their own circumstances. Investors should consult their own qualified estate planning attorney, tax professional, and financial advisor before implementing any estate planning strategy.

Important Disclosure Regarding Delaware Statutory Trust (DST) Investments

Delaware Statutory Trust ("DST") investments are generally offered through private placement offerings and are intended only for investors who satisfy the eligibility requirements established by the issuer and applicable securities laws. In many cases, DST offerings are available only to investors who qualify as accredited investors.

DST investments are not suitable for all investors. They are generally illiquid, are not listed on a public exchange, and involve investment risks, including the possible loss of principal. Investment objectives, risks, fees, expenses, tax considerations, and offering terms vary by investment and should be carefully reviewed before investing.

Nothing in this material constitutes an offer to sell or a solicitation of an offer to buy any specific DST investment. Any offer may be made only by means of the applicable private placement memorandum and other offering documents. Investors should carefully review these materials and consult with their legal, tax, and financial advisors to determine whether a DST investment is appropriate in light of their individual circumstances.

1031 Exchange Disclosure: DST investments are often used as replacement property in connection with Section 1031 like-kind exchanges. Investors should consult with their qualified tax advisor regarding the tax consequences and eligibility requirements associated with a 1031 exchange. Neither this material nor the adviser provides legal or tax advice.

Why work with us, and how to judge anyone you'd trust with this

Many people selling an appreciated rental take advice from someone who earns more when they pick a particular door. That is the thing to watch for. Before you hand anyone a six-figure tax decision, ask four questions. Here is how we answer them.

How are you paid? We are fee-based. Our fee schedule is on our Fees page. We earn no commission on investments or DST placements. Our fee depends on what we manage for you. If you pay the tax, or exchange into a property you run yourself, there is no ongoing advisory fee on it. Want to check the numbers without us in the room? Our tax-on-sale calculator estimates the tax on a sale, and what a 1031 exchange or DST would defer, from the figures you enter; it doesn't recommend a path. Our decision tree walks through the options from your answers.
Are you a fiduciary? Yes. Advisory services run through Savvy Advisors, an SEC-registered investment advisor, which carries a legal duty to act in your interest, not merely to recommend something "suitable."
Do you actually specialize in this? I hold a Series 65 license; I have spent more than a decade working specifically on 1031 and DST transactions. Real estate is in my family, so the stakes here are not abstract to me. This is a narrow, technical corner of tax and real estate, and it is the corner I have chosen to know deeply. The California details in this article, the ones many advisors gloss over, are the daily work.
Will you give me the answer you can't sell? Yes. If the right move is to just pay the tax, we say so. There is no product we need to move. We are the sling, not a salesman with a quota.

Savvy is the platform behind the advice: a technology-forward, SEC-registered advisor built to take the friction out of the client-advisor relationship, with straightforward access to your information and broad access to most DST providers, so your options are not limited to a single sponsor's shelf.

If an advisor cannot answer those four cleanly, keep looking. If you want to walk your own numbers with someone who can, that is a conversation, not a sales pitch.

Sources

Book a call →

If I 1031 my California rental into an out-of-state property, does California still tax me?