CPA-led 1031 exchange guide
1031 Exchange & Capital Gains Tax
A properly executed 1031 exchange defers four different taxes on real estate gains: federal capital gains, state income tax, depreciation recapture, and the net investment income tax. Together those can run 30–40% of your gain — money that stays in the deal instead of going to the IRS.
What gets deferred
- Federal long-term capital gains (up to 20%)
- State capital gains tax (varies, up to ~13% in CA)
- Depreciation recapture (25% federal on prior depreciation)
- Net investment income tax (3.8% for high-income investors)
Deferral vs forgiveness
A 1031 exchange defers tax; it does not forgive it. The gain rolls into the replacement property's basis. If you ever sell the replacement without doing another exchange, the deferred gain becomes taxable then. Many investors use a chain of exchanges to defer indefinitely, with the basis ultimately stepping up at death.
California-specific note
California requires Form 593 reporting on the sale and tracks deferred California gain even when the replacement property is out of state. Brandon coordinates this filing as part of the exchange.
Frequently Asked Questions
Does a 1031 eliminate the tax?
It defers, not eliminates. The gain carries into the replacement property's basis. With proper estate planning, the deferred gain can be stepped up at death.
Are state taxes also deferred?
Yes, in nearly every state. California requires extra reporting (Form 593 and FTB 3840) but the deferral itself is recognized.