Exchanging Into a No-Income-Tax State: What You Save and What Follows You

What you save: state tax on the replacement's rent and future growth, once you are not a resident elsewhere

Real property income is taxed by the state where the property sits, and a state with no personal income tax simply has nothing to collect. Texas's constitution bars a tax on the net incomes of individuals, including their share of partnership income. The South Dakota Department of Revenue describes the state as one of seven without an income tax. Tennessee repealed its Hall tax on investment income for tax years beginning in 2021, and New Hampshire repealed its interest and dividends tax, RSA chapter 77, effective January 1, 2025.

Alaska, Nevada and Wyoming are covered on their state pages, along with transfer taxes, which several no-income-tax states still levy at closing.

The saving on a replacement is therefore its rent and the appreciation that builds after you buy it. Whether that saving reaches you depends on where you live, which the next two sections address.

What follows you: your old state's claim on the gain you deferred

California is the most explicit. The Franchise Tax Board requires Form FTB 3840 for the year you exchange California property for property elsewhere and every year after until the California-source deferred gain is recognized, and the duty survives later exchanges. When you finally sell, you report the lesser of the deferred California-source gain or the gain you actually recognize. The FTB 3840 instructions cite R&TC section 18032 and allow the FTB to assess tax, penalties and interest if you stop filing.

Oregon's Form OR-24 is due for the year of an exchange of Oregon property for property outside Oregon and annually after until the like-kind property is disposed of. Massachusetts' 830 CMR 62.5A.1 does not tax the deferred gain at exchange, but treats the part of a later gain that reflects Massachusetts appreciation as Massachusetts-source. Montana's Admin. R. 42.2.308 says gain on Montana property keeps its Montana-source character until recognized.

If your old state is not one of these, check its page on whether a 1031 defers state capital gains tax before assuming the gain is free of it.

Your home state taxes everything while you live there

California's residency guidance, FTB Publication 1031, states that residents are taxed on all income regardless of source and that real property income is sourced where the property is located. A California resident who owns Texas property pays California tax on the Texas rent; the only state that stops taxing it is the one that never did.

Residence turns on domicile and where your closest connections are, and the same publication lists factors such as where you are registered to vote, where your social ties are and where your real property and investments are. A new deed in Texas is one factor among many, so time the move and the paperwork, not just the purchase. A sale of California property agreed before you move out stays taxable by California under the publication's installment-sale table.

Washington is a special case, and transfer taxes still apply at the border

Washington has no individual income tax today, and its capital gains tax exempts real estate under RCW 82.87.050. But the Department of Revenue states that a new 9.9% income tax will apply from January 1, 2028 to individuals and joint filers with adjusted gross income above $1 million, with the first returns due in 2029. A seller planning a large future sale in Washington should read the final rules before relying on today's position.

Transfer and recording taxes are separate from income tax and apply in several no-income-tax states. Check the closing costs for the state you are buying in on its state page.

Worked model: a California rental into Texas, then a move

Hypothetical round numbers. A California resident exchanges a California rental with $800,000 of deferred gain into DST interests holding Texas property. While she remains a California resident, California taxes her Texas rent, and she files FTB 3840 each year.

Three years later she moves to Texas and genuinely changes residence. Five years after that the trust sells and her recognized gain is $1,100,000: the $800,000 deferred plus $300,000 of appreciation on the Texas property. Under the FTB's rule she reports the lesser of the deferred California-source gain or the recognized gain, so $800,000 to California as a nonresident. The $300,000 is Texas-source, earned while a Texas resident, and Texas does not tax it. Federal tax applies to all $1,100,000 unless she exchanges again, in which case the FTB 3840 obligation continues. Run your own numbers with your CPA.

DST income in a no-tax state: where the trust's property sits decides the filing

A DST investor is treated as owning its share of the real estate under Rev. Rul. 2004-86, so rent from a trust's Texas property is Texas-source and needs no Texas return, while a trust holding property in a taxing state may need one there. If the goal is fewer state returns, the location of each trust's property matters as much as the sponsor; diversifying out of one market and DST multi-state tax issues show the trade-off.