A properly structured like-kind exchange under Internal Revenue Code §1031 allows investors to defer recognition of capital gains and depreciation recapture at the federal level. To report the transaction, taxpayers must file IRS Form 8824, Like-Kind Exchanges, which details the properties involved, the timeline of the exchange, and any realized or recognized gain, including taxable “boot.” This form establishes the foundation for tracking deferred gain and adjusted basis, which will carry forward into future transactions or eventual disposition. In some cases where there is taxable income, the IRS Form 4797, Sale of Business Property, may be required as well.
While federal reporting provides the baseline framework for a 1031 Exchange, the state-level treatment of a 1031 Exchange requires additional consideration. Investors must evaluate the rules in both the state where the Relinquished Property is located and the state where the Replacement Property is acquired, as each jurisdiction may impose its own requirements. Below we will discuss the most prominent considerations for a 1031 Exchange at a state-level including withholding, reporting, community property rules, and proper Qualified Intermediary (QI) state regulations.
States with Income Tax
All states will follow federal law and allow investors to defer state capital gains and related taxes when completing a qualifying like-kind exchange under Internal Revenue Code §1031. However, conformity is not always absolute. Some states adopt federal rules on a rolling basis, while others conform to a fixed date version of the Internal Revenue Code or selectively decouple from certain provisions.
As a result, even in states that recognize 1031 Exchanges, investors may encounter additional requirements such as state-specific reporting, non-resident withholding, or adjustments to how gain is calculated and tracked. These variations can impact both the timing and extent of state tax deferral in an exchange.
Understanding these state-specific considerations can help investors avoid unexpected tax liabilities and ensure their exchange is structured properly.
States Without State Income Tax
While States with an income tax generally conform to the federal regulations, some states do not impose a state income tax at all. So, when a Relinquished Property is located in one of these states, there is typically no state-level capital gains tax to defer, meaning the exchange generally does not need to be reported on a state income tax return.
States without state income tax include:
- Alaska
- Florida
- Nevada
- South Dakota
- Tennessee
- Texas
- Wyoming
Because these states do not tax individual income, a 1031 Exchange involving property located there generally only requires federal reporting on IRS Form 8824.
States with Non-Resident Withholding or Reporting Requirements
Certain states require additional documentation or withholding when real estate is sold by a non-resident Taxpayer, even when the transaction is part of a 1031 Exchange.
States with withholding or reporting requirements include:
- Alabama
- California
- Colorado
- Georgia
- Hawaii
- Maine
- Maryland
- Mississippi
- New Jersey
- New York
- North Carolina
- Oregon
- Rhode Island
- South Carolina
- Vermont
- West Virginia
These rules are designed to ensure the state collects taxes owed if the transaction ultimately becomes taxable. Investors completing an exchange involving property in one of these states should work closely with their Qualified Intermediary and tax advisor to ensure all required forms and documentation are submitted. In the case of withholding, many states allow the taxpayer to apply for an exemption.
California’s Unique Reporting Requirements
California has one of the most comprehensive reporting systems for 1031 Exchanges. The state requires sellers to certify the exchange and may require withholding in certain situations.
California withholding requirements are generally reported using California Franchise Tax Board Form 593.
Common scenarios include:
- Simultaneous Like-Kind Exchange – No withholding is typically required if the seller certifies that the transaction qualifies as a simultaneous exchange. However, if the seller receives boot (cash or non-like-kind property) exceeding $1,500, withholding may apply at 3⅓ percent of the taxable amount, unless an alternative calculation is elected.
- Deferred Like-Kind Exchange – For delayed exchanges, withholding may also apply if the seller receives taxable boot exceeding $1,500.
- Failed Exchange – If an exchange fails or does not meet IRC §1031 requirements, the Qualified Intermediary or exchange accommodator may be required to withhold 3⅓ percent of the total sales price, unless an alternative withholding calculation is elected.
California also requires ongoing tracking of certain California property is sold but the replacement property is acquired in a different state using FTB Form 3840, allowing the state to monitor deferred gains.
Because of these detailed requirements, exchanges involving California property often require careful coordination between the seller, tax advisor, and Qualified Intermediary.
Clawback States
Some states have implemented “clawback” rules to track deferred gains when property located in their state is exchanged for property located in another state.
Under these rules, if the Replacement Property is eventually sold in a taxable transaction, the original state may require the Exchanger to report and pay tax on the gain attributable to the original property.
States with clawback provisions include:
- California
- Massachusetts
- Montana
- Oregon
Each of these states has its own procedures for tracking deferred gains and reporting them when the Replacement Property is ultimately sold. For exchangers with a relinquished property in one of these states, it’s advisable to consult a tax advisor or refer to the applicable state tax authority’s website for additional guidance.
Community Property State Considerations
Another state tax consideration is whether the Relinquished or Replacement Property is located in a community property state.
In community property states, property acquired during marriage is generally considered jointly owned by both spouses regardless of how the property is titled, unless otherwise structured. This can affect how title is held during an exchange and how entities such as limited liability companies (LLCs) are treated for tax purposes.
In certain circumstances, a married couple owning property together in a community property state may be able to form a two member LLC treated as a disregarded entity for tax purposes, even though both spouses are members.
Community property states include:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
Investors considering entity structures for their exchange should consult with their legal and tax advisors to ensure compliance with both state property laws and federal tax rules.
State Regulations for Qualified Intermediaries
In addition to tax rules, some states have enacted legislation regulating Qualified Intermediaries (QIs) and other exchange facilitators.
These regulations are designed to protect exchange funds and may require QIs to maintain certain safeguards such as fidelity bonds, escrow accounts, or minimum financial standards.
States with exchange facilitator regulations include:
- California
- Colorado
- Idaho
- Maine
- Nevada
- Virginia
- Washington
Working with an experienced exchange company that understands state regulations can help ensure that funds are handled properly and that the exchange complies with all applicable requirements.
State tax treatment of 1031 Exchanges can vary widely depending on the location of the Relinquished Property, the Replacement Property, and the residency of the Exchanger. In addition to federal requirements, investors may need to navigate state withholding rules, reporting obligations, clawback provisions, and entity considerations.
Because of these complexities, it is important for investors to consult with both a qualified intermediary and a tax professional before initiating a 1031 Exchange.