Does a 1031 exchange defer state capital gains tax too?

The deferral rides in on the federal number your state return starts from

State income tax is usually computed from federal taxable income or federal adjusted gross income with a list of add-backs, and §1031 deferral is baked into that starting number rather than claimed separately. The question to ask about any state is therefore narrow: has it decoupled from §1031, and does it want an information return?

California answers the first half in its own form instructions: "In general, California law conforms to the Internal Revenue Code (IRC) as of January 1, 2025," and "For taxable years beginning on or after January 1, 2025, like-kind exchanges are limited to real property," tracking the federal rule. Each state's page under 1031 exchange rules by state carries its own conformity date.

A state with no individual income tax on this gain collapses the question to the federal layer plus whatever the state where the property sits wants from you. What the federal deferral is, and what it is not, is set out on tax-free or deferred.

• Ask two things about any state: has it decoupled from §1031, and does it want an annual information return?
• Ask a third if you are selling out of state: does the closing agent have to hold back cash at the table?
• The answers are set by the state where the relinquished property sits, not by where you live or where the replacement is.

A claw-back state keeps its claim after the money leaves the state

California's rule is written as a sourcing rule, not a denial of the exchange: "The source of a gain or loss from the sale or exchange of property located in California is determined at the time the gain or loss is realized. The source of such gain or loss is preserved without regard to when such gain or loss may be recognized."

Hypothetical. You sell a Sacramento fourplex for $1.4 million with $600,000 of realized gain and exchange into DST interests holding property in Texas and Georgia. Nothing is due to California in the exchange year, but the $600,000 stays California-source, and when the trusts sell twelve years later California taxes that $600,000 on a California return.

The trigger is geographic, not residential. Form FTB 3840 applies to "All taxpayers who conduct an IRC Section 1031 exchange, regardless of residence status or commercial domicile, who exchange real property located in California for like-kind property located outside of California."

FTB 3840: one form per exchange, filed every year, even with no other California return

The form is due with your California return, or on its own if you have no California filing requirement, by April 15 for individuals, estates and trusts on a calendar year, with an extended date of October 15. Partnerships and S corporations file a month earlier.

It must be filed "for the taxable year of the exchange and for each subsequent taxable year, generally until the California sourced deferred gain or loss is recognized on a California tax return," and a separate form goes in for each exchange when more than one California property was given up.

Skipping it is not a quiet omission. Where a taxpayer neither files the form nor files a return, "the FTB may issue a Notice of Proposed Assessment to adjust the income for the California sourced deferred gain and assess tax plus any applicable penalties and interest," which means the state can assess the whole deferred gain at its own timing.

• Individuals, estates and trusts on a calendar year: April 15, extended to October 15.
• Partnerships, LLCs taxed as partnerships and S corporations: March 16, with extensions of six or seven months.
• Taxpayers with no other California filing duty sign Side 1 and mail the form on its own.
• A multi-asset exchange and a second California property each get their own treatment on the form.

Oregon runs the same idea through Form OR-24

Oregon's like-kind rules sit in ORS 316.738 and 317.327, and Publication OR-17 sets the filing duty: if Oregon real property is exchanged for real property in another state, "include Form OR-24 with your Oregon return in the year of the exchange or conversion," and "Submit the form to us each year, until you've disposed of the like-kind property, even if you don't have to file an Oregon income tax return."

Recognition follows the federal return. A full-year resident reports the Oregon gain "when it's reported on your federal return"; someone who was a nonresident at the time of the exchange, or who is a nonresident when the gain finally lands, files Form OR-40-N to report it.

Two states with similar machinery still differ on which property triggers the duty and how the deferred figure is tracked, so read the state page for the property you are selling rather than assuming your neighbour's paperwork.

Deferral says nothing about what the closing agent does with your money

A state can conform to §1031 in full and still require cash to be held back at the closing table, because withholding is a collection device aimed at sellers who may never file. California exempts the exchange itself from withholding on Form 593 but makes the qualified intermediary withhold once boot exceeds $1,500, and the mechanics differ state by state.

Certifying the exchange before the deed records is what prevents the hold-back, and the forms, rates and failure rules are set out on state withholding at closing.

Anything held back leaves the transaction and only comes back through that state's return, so size the replacement purchase on what the intermediary actually receives.

What multiplies when the replacement is a DST in several states

A trust holding property in four states can create a filing duty in each of them, which is a different cost from the deferral question and one worth pricing before you identify. State tax and multi-state filing for DST investors works through that, and choosing DST asset classes covers the geography that drives it.

Where the replacement sits also decides which state gets the gain the second time around, a calculation laid out on buying in another state and on what you owe when you finally sell. Confirm your own state's treatment and any annual return with your CPA or attorney before the identification deadline.

Breakwater Exchange is a 1031 exchange broker licensed in all fifty states within a regulated broker-dealer framework, working with vetted national DST sponsors, so we can tell you where a given offering's properties are located before you commit to it.