A Comprehensive Guide to 1031 Exchange Rules by State

A 1031 exchange allows real estate investors to defer capital gains taxes when selling an investment property, provided they reinvest in a “like-kind” property within a specific timeframe. While federal law provides a framework for tax-deferred exchanges, individual states impose varying rules that can impact the transaction’s execution and tax benefits.

As of 2025, understanding these state-specific nuances is critical for investors seeking to maximize their tax advantages while ensuring compliance with local regulations.

1. State Income Taxes: Is Your Exchange Fully Deferred?

Not all states conform to federal 1031 exchange tax treatment, meaning that while federal taxes may be deferred, state-level tax obligations can still apply.

• California:
  • While California follows federal 1031 rules, it has a claw-back provision that allows the state to recapture deferred gains if the relinquished property was sold in California, but the replacement property is later moved out of state.
  • California requires specific reporting forms, such as Form 3840 (California Like-Kind Exchanges), to track exchanges.
  • Non-residents selling California property as part of a 1031 exchange may be subject to state withholding tax unless pre-approved filings are completed in advance.
• Oregon & New York:
  • Oregon generally conforms to federal rules with minimal state-specific variations.
  • New York requires a separate state filing to recognize tax deferral. Additionally, New York City imposes local taxes that may impact whether full deferral is possible.

For investors in non-conforming states, state tax deferral may be limited or subject to unique conditions, making professional tax guidance essential.

2. Non-Resident Withholding Taxes: Advance Filings May Be Required

Non-residents selling property in certain states must file additional forms to avoid automatic withholding taxes at the time of closing. These filings often require pre-approval before deed recording:

• New York (IT-2663): Can be filed at the closing table.
• Maryland: Must be submitted and pre-approved days ahead of closing.
• California & South Carolina: Require non-resident withholding filings, which must be planned in advance to avoid delays or unexpected tax withholdings.
  
  

3. Depreciation Recapture: State-Level Variations

Depreciation recapture rules can differ by state, potentially leading to unexpected tax liabilities.

• Colorado: Generally follows federal depreciation recapture rules, though local tax implications may apply.
• Texas: Has no state income tax, which simplifies exchanges. However, depreciation recapture should still be factored into overall tax planning.

Given these complexities, investors should consult with tax professionals to ensure they fully understand their state’s depreciation recapture policies.

4. State-Specific Transfer Taxes & Exemptions

While 1031 exchanges defer capital gains taxes, some states impose transfer taxes, which may still apply:

• Washington & Hawaii: Require real estate excise or conveyance taxes, even in a 1031 exchange.
• Pennsylvania: Generally does not provide transfer tax exemptions for controlling interest transfers of LLCs involved in reverse exchanges. However, the 89-11 structure may help mitigate double taxation when working with sophisticated tax counsel in the state.

Some states do provide exemptions for certain LLC transfers, particularly in reverse exchanges (LLC interest transfers from EAT back to the taxpayer). Understanding these distinctions is crucial when structuring an exchange.

5. State-Specific Reporting & Compliance Requirements

Many states require additional reporting beyond federal forms:

• Illinois & Minnesota: Require specific tax disclosures to track the deferred gain and maintain compliance.
• California, Maryland, New York, South Carolina: May require additional non-resident withholding tax forms (see Section 2).

Failure to comply with these state-level reporting requirements could result in tax liabilities or penalties, making it essential to stay informed on evolving regulations.

6. State Residency & Its Impact on 1031 Exchanges

An investor’s state of residency can significantly impact tax treatment:

• High-tax states (e.g., New Jersey, Maryland, New York): May impose state taxes based on residency, even if the exchanged property is located elsewhere.
• No-income-tax states (e.g., Florida, Texas, Nevada): Provide cleaner exchanges with fewer state-imposed tax concerns.

For investors relocating after an exchange, consider potential state claw-back provisions (e.g., California) that may apply.

7. Pennsylvania Joins the List: 1031 Exchanges Now Available in All 50 States

As of 2025, Pennsylvania now allows 1031 exchanges, making it the final state to conform to federal tax-deferred exchange rules. Previously, Pennsylvania had restrictions that complicated exchanges for in-state investors. This change streamlines investment strategies, ensuring that 1031 exchanges are now possible in all 50 states.

Final Thoughts: Maximizing 1031 Exchange Benefits

Successfully navigating a 1031 exchange requires an in-depth understanding of both federal and state tax regulations. While federal law establishes a broad framework for tax deferral, state-specific requirements introduce additional complexities, from income tax obligations to withholding and reporting requirements.

Key Takeaways:

- Confirm whether your state fully allows tax deferral.
- Understand state-specific depreciation recapture rules.
- Prepare for non-resident withholding tax filings (if applicable).
- Consider transfer tax exemptions or double taxation risks in LLC structures.
- Ensure compliance with state-specific reporting requirements.
- Factor in state residency tax implications (including claw-back provisions).

Before proceeding with a 1031 exchange, consult with tax professionals familiar with both federal and state tax laws.

For further guidance or to begin your exchange, contact us or visit www.1031dst.com for expert assistance.

Thank you!

Important Disclosures:

*This material is for informational purposes only and does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). This material is not to be interpreted as tax or legal advice. IRC Section 1031 is a complex tax concept; therefore, you should consult your legal or tax professional regarding the specifics of your individual situation. *There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. *DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million exclusive of primary residence, and/or possessing an annual income of over $200,000, or $300,000 with a spouse and expects the same or greater for the current year) and accredited entities (generally described as an entity owned entirely by accredited investors and/or owning investments in excess of $5 million). Please check with a qualified CPA or attorney to determine if you are accredited. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA) Fortitude Investment Group is independent of CIS, CAM, and CIA.