Does a 1031 Exchange Defer State Taxes?

Federal §1031 deferral is automatic on every conforming exchange. State-level treatment is where most investors get tripped up — the rules vary widely, and what counts as compliant in one state can produce an unexpected tax bill years later in another. The starting question is which of three categories your state falls into.

The Three State Categories (Conform, No Tax, Clawback)

States approach §1031 in one of three ways:

• Conforming states. The state's tax code references the Internal Revenue Code and accepts §1031 deferral the same way the federal government does. The state-level gain is deferred when the federal gain is deferred. Most states fall in this bucket — including New York, Illinois, Pennsylvania, Ohio, Georgia, North Carolina, Virginia, and Colorado.
• No-income-tax states. Nine states impose no individual income tax on capital gains — meaning §1031 deferral is academic for state purposes. Includes Nevada, Florida, Texas, Washington, Tennessee, Wyoming, South Dakota, Alaska, and New Hampshire (with a small interest/dividend tax).
• Clawback states. California, Oregon, and Massachusetts have explicit statutes that allow §1031 deferral but require the deferred state gain to be reported and tracked annually. When the replacement property is eventually sold without another exchange, the state-level gain attributable to the original in-state property is "clawed back" and taxed.

The category your state falls into governs the lifetime tax cost of an exchange — and which states make sense as replacement-property destinations.

No-Income-Tax States (NV, FL, TX, WA, TN, etc.)

Investors in no-income-tax states get the cleanest §1031 outcome: federal deferral applies, no state-level deferral is needed because no state tax exists in the first place. The only state-level consideration is transfer tax (documentary stamp tax in Florida, transfer tax in some other jurisdictions), which applies at closing regardless of §1031 status.

Nine states with no individual income tax on capital gains:

• Nevada — no state income tax (Simple 1031 LLC's HQ).
• Florida — no state income tax; $0.70 per $100 documentary stamp tax on conveyances.
• Texas — no state income tax.
• Washington — no state income tax (a 7% capital gains tax exists for high-income earners on certain assets, but real estate is exempt).
• Tennessee — no state income tax.
• Wyoming — no state income tax.
• South Dakota — no state income tax.
• Alaska — no state income tax.
• New Hampshire — no income tax on wages or capital gains; small tax on interest and dividends.

Investors who 1031 from a clawback state into a no-income-tax state are still subject to the source state's clawback rules — moving to Nevada does not erase California's claim on a California-origin gain.

California's FTB 3840 Clawback (In Detail)

California is the most aggressive clawback state and the most-asked-about case. The relevant statutes are R&TC §18032 (individuals) and R&TC §24953 (corporations), enacted in 2013. The rules apply to any §1031 where a California property is exchanged for property outside California.

The mechanics:

1. The taxpayer files an annual FTB Form 3840 for every year between the original §1031 closing and the eventual final sale. The form tracks the deferred California gain.
2. The taxpayer's status — California resident or nonresident — does not matter. The clawback follows the property, not the person.
3. When the replacement is finally sold without another §1031, California taxes the original deferred gain at California rates (up to 13.3% top rate plus 1% mental-health surtax for high earners).
4. Subsequent §1031 chains continue the deferral as long as 3840 filings are maintained on each link of the chain.

Missing 3840 filings creates an audit risk. The Franchise Tax Board takes the position that the clawback gain is owed in the year of the missing filing if records cannot be reconstructed. Penalties include $1,000 per missed filing plus interest from the original §1031 closing.

Oregon and Massachusetts Clawback Mechanics

Oregon and Massachusetts have similar but less aggressive clawback rules:

• Oregon: ORS §314.290 (the "look-back" provision) requires Oregon to tax a 1031 of Oregon property when the replacement is eventually sold. There is no annual filing analogous to FTB 3840 — Oregon tracks the gain through its own records and asserts the claim at sale. Oregon's top capital gains rate is 9.9%.
• Massachusetts: M.G.L. c.62 §63 imposes a similar look-back rule. Massachusetts does not require an annual filing during deferral but tracks the deferred gain administratively. Massachusetts' capital gains rate is 5%.

Both states' rules apply only to property that originated in their state. A Massachusetts resident who exchanges a Florida property for a New York property is not subject to Massachusetts clawback because the relinquished property was not Massachusetts-source.

Nonresident Withholding (593-C, NJ, etc.)

Many states require withholding on real estate sales by nonresidents, separate from the state-conformity question. A few common ones:

• California Form 593: 3.33% withholding on the gross sale price for any nonresident seller. A §1031 exchange can be exempt from withholding by filing Form 593 with the appropriate exemption code at closing — but the form must be completed and provided to the title company. Missing the form triggers withholding even on a fully compliant 1031.
• New Jersey GIT/REP-3: Nonresident sellers face withholding at higher of 8.97% of gain or 2% of consideration. §1031 exchanges qualify for an exemption with the proper certification at closing.
• Maryland MW506NRS: 8% nonresident withholding on the gross consideration. §1031 exchanges qualify for exemption with Form MW506AE.
• Other states: Hawaii, North Carolina, South Carolina, Vermont, and several others have similar nonresident withholding regimes with §1031 exemption procedures.

The pattern is consistent: §1031 exemption from withholding is available, but only when the proper form is completed at closing. Title companies and Qualified Intermediaries handle these routinely on out-of-state exchanges, but the documentation must actually be done.

Simple 1031 LLC documents the source-state and destination-state tax considerations in the exchange agreement and coordinates withholding-exemption forms with the title company. We are a Qualified Intermediary and do not provide tax, legal, or investment advice — state-level tax planning, FTB 3840 filings, and nonresident withholding analysis are CPA work.

Frequently Asked Questions