California's clawback is a state-level lookback rule that requires annual FTB Form 3840 filings on any §1031 exchange where California property is exchanged for out-of-state replacement property. When the replacement is eventually sold without another §1031, California taxes the original deferred California-source gain at California rates regardless of where the taxpayer lives at the time of sale. Statutes: R&TC §18032 (individuals) and §24953 (corporations), enacted in 2013.
California's clawback is the most aggressive state-level §1031 rule in the country and the one most likely to surprise out-of-state investors. The rule was enacted in 2013, applies retroactively to active §1031 chains that were already in deferral, and has produced years of confusion as practitioners and the Franchise Tax Board have worked through the application.
R&TC §§18032 and §24953 (the Statute)
The clawback authorities are California Revenue & Taxation Code §18032 for individuals and R&TC §24953 for corporations and other business entities. Both were enacted in 2013 (effective for exchanges completed on or after January 1, 2014) as part of California's response to a perceived loophole in the previous treatment of out-of-state replacement property.
The core rule, in plain language:
- If a taxpayer exchanges California real property for non-California replacement property under §1031, the deferred California-source gain is "tracked" through annual filings.
- When the replacement property is eventually sold or otherwise disposed of in a non-§1031 transaction, California taxes the original deferred gain at California rates.
- The taxpayer's residency status at the time of final sale does not matter — the clawback follows the property's California origin, not the taxpayer.
Pre-2013, California allowed §1031 deferral but had limited tools to track or claim the eventual gain on out-of-state replacements. The 2013 statutes closed that gap by creating the FTB 3840 annual-filing mechanism and codifying the lookback claim.
The Annual FTB 3840 Filing Requirement
The operational backbone of the clawback is FTB Form 3840 — a one-page (occasionally two-page) annual report that the taxpayer files for every year between the original §1031 closing and the eventual final sale. The form discloses:
- The original California property and its sale date.
- The out-of-state replacement property currently held.
- The deferred California-source gain (and the basis of that calculation).
- Any subsequent §1031 exchanges that continued the chain.
The form is filed with the California return (Form 540, 540NR, or 100) for each year. The first filing is due with the return covering the year of the original §1031 closing; subsequent filings continue annually until the chain is broken by a final non-§1031 sale.
Practical points:
- The filing applies even if the taxpayer is a nonresident at the time of the §1031 — the California-source character of the original property triggers it.
- Multiple §1031 chains require multiple 3840 filings (one per chain).
- The filing burden is small, but missing it creates compounding penalties.
California-origin 1031 question?
We document FTB 3840 obligations in every California-origin exchange agreement. $799 flat-fee forward exchanges; same-day exchange opening on the first call.
Call (725) 224-5008What Triggers the Clawback to Come Due
The clawback claim becomes payable when the replacement property is sold or otherwise disposed of in a non-§1031 transaction. Triggers:
- Cash sale of the replacement. The most common trigger. California taxes the original deferred gain in the year of sale.
- Conversion to personal use followed by sale. If the taxpayer converts the replacement to a primary residence and later sells under §121, the §121 exclusion does not bar the California clawback claim on the original deferred gain.
- Death of the taxpayer. A complicated edge case. The federal §1014 step-up generally eliminates the federal deferred gain, but California's clawback position has been that the state-level claim survives the step-up. The FTB has not litigated this aggressively, and tax planners often rely on the federal step-up for the California gain as well — but the position is not settled.
- Breaking the §1031 chain with boot. If a subsequent exchange in the chain creates substantial boot, the clawback comes due to the extent of the recognized gain.
The amount taxed is the original California-source deferred gain — not the full appreciation since exchange. If you sold a California property for $1M with $500K deferred gain, exchanged into out-of-state property, held for 10 years, and the out-of-state property appreciated to $1.5M, California's clawback claim is on the original $500K (taxed at California rates), not the full $1M of cumulative gain.
Chain Exchanges (3840 Extends Across Each)
The clawback survives subsequent §1031 exchanges. Each new replacement property in the chain inherits the FTB 3840 obligation. The taxpayer must continue filing 3840 each year for as long as the chain continues, even when the chain has moved through multiple non-California replacement properties.
Worked example:
- 2015: Sell Los Angeles rental for $800K, defer $300K of California-source gain. Buy Texas rental for $800K. FTB 3840 filed annually starting 2015.
- 2020: Sell Texas rental in §1031 for $1.1M. Buy Florida rental for $1.1M. FTB 3840 obligation continues. The original $300K California-source deferred gain is still tracked.
- 2027: Sell Florida rental in cash sale for $1.5M. Final California clawback claim: $300K (the original deferred gain) × California rate.
The Texas and Florida appreciation is not California-source and is not subject to the clawback. Only the original $300K from the LA rental is.
Penalties for Missing 3840 Filings
The FTB takes 3840 filing seriously. Penalties for missing filings:
- $1,000 per missed year under R&TC §19141 (failure to file information returns).
- Compounding interest on the eventual clawback amount, calculated from the date the original deferred gain would have been due if the §1031 had failed (i.e., from the original §1031 closing year).
- Statute of limitations extension. Missing 3840 filings can extend California's audit window indefinitely, since the gain remains "open" until reported.
- Reconstructive assessment risk. If the taxpayer cannot provide records of the original §1031 (basis, deferred amount, replacement property identification), the FTB may assert a higher gain figure based on its own reconstruction.
The math: a taxpayer who missed five years of 3840 filings on a single chain owes $5,000 in penalties before the substantive tax claim is even calculated. Reconstructive assessments based on incomplete records often produce gain figures higher than what the taxpayer would have reported voluntarily.
The cure is annual filing discipline. The form takes 30 minutes to complete and costs nothing. Most CPAs roll FTB 3840 into the annual California return preparation as a matter of course for clients with active §1031 chains.
Simple 1031 LLC documents the FTB 3840 obligation in every California-origin exchange agreement and provides the source data to the taxpayer's CPA for ongoing filings. We are a Qualified Intermediary and do not provide tax, legal, or investment advice — California clawback compliance, including annual 3840 preparation and filing, is CPA work.
Frequently Asked Questions
Do I need to file FTB 3840 every year after a 1031?
Yes — for every year between the original California-origin §1031 closing and the eventual final non-§1031 sale of the replacement property. The form is filed with the California return (Form 540, 540NR, or 100). Multiple §1031 chains require multiple 3840 filings (one per chain). The filing requirement continues even if the taxpayer becomes a California nonresident, because the clawback follows the property's California origin, not the taxpayer's residency.
Does moving out of California eliminate the clawback?
No. California's clawback follows the original property, not the taxpayer's residency. A California resident who exchanges a California property for a Texas property, moves to Texas, and eventually sells the Texas replacement in a non-§1031 sale still owes California tax on the original deferred gain. The taxpayer's residency at the time of the final sale is irrelevant — what matters is whether the property in the §1031 chain originated in California.
What if I do a 1031 within California?
If both the relinquished and replacement properties are in California, no clawback applies — the gain stays California-source throughout. FTB 3840 is not required for in-state exchanges. The clawback specifically targets out-of-state replacements where California would otherwise lose its claim on the eventual gain.
How does the clawback apply to DSTs?
If the DST holds non-California property, the clawback applies the same way it would to a direct-deed out-of-state replacement. The taxpayer files FTB 3840 annually tracking the deferred California gain, and the clawback comes due when the DST sponsor sells the underlying property and the taxpayer does not roll into another §1031. If the DST holds California property, the gain stays California-source and no clawback applies.
What's the penalty for missing a 3840 filing?
$1,000 per missed year under R&TC §19141, plus interest compounding from the original §1031 closing year, plus statute-of-limitations extension that keeps the gain open indefinitely. The FTB can also assert a reconstructive assessment based on its own records if the taxpayer cannot produce documentation. The cumulative cost of missed filings often exceeds the tax that would have been due on a clean voluntary report.
California-origin 1031?
Simple 1031 LLC handles QI mechanics for California-origin exchanges and documents FTB 3840 obligations on every file. $799 flat fee for forward exchanges, $5M Fidelity Bond and $10M E&O coverage.