Most owners we sit down with aren’t asking how a 1031 exchange works. They’re asking what happens after they sell.

The building has been the income, the routine, and sometimes the whole plan for decades. Selling it can feel like walking away from all of that at once. For a lot of owners, a 1031 exchange is what makes the decision feel possible. You sell the building. You stay in real estate. And the tax bill you’ve been building for decades doesn’t come due yet.

Here’s how a 1031 exchange works in California and what we’d want you to know before you start.

Note: This article is general information, not tax or legal advice. Talk to your CPA and a qualified intermediary before starting an exchange.

Ready to plot your next chapter? Book a consultation with our team.

What You’d Owe Without an Exchange (Capital Gains)

When you sell an investment property, you’re taxed on the gain: the difference between what you sell for and your adjusted basis. Adjusted basis is roughly what you paid, plus improvements, minus the depreciation you’ve taken over the years.

That last part catches long-term owners off guard. Say you bought for $1,000,000 and sold for $3,000,000. Your gain isn’t just $2,000,000. Years of depreciation lower your basis and raise your gain, and the depreciation portion is taxed separately as recapture. For an owner who’s held since the 80s or 90s, the combined federal and California bill can take a real share of the proceeds.

How a 1031 Exchange Defers Taxation

Section 1031 of the tax code lets you defer that tax if you reinvest the proceeds into another investment property. The IRS treats it as a trade, not a sale.

The word that matters is defer. The tax doesn’t disappear. It carries forward into the next property and comes due if you eventually sell without exchanging again. How long to keep exchanging is a planning conversation worth having with your CPA.

Two terms you’ll hear: the relinquished property (also called the “downleg”) is the building you’re selling. The replacement property (the “upleg”) is what you’re buying.

The Rules You Can’t Bend

A 1031 exchange is flexible about what you buy and strict about how you do it.

You never touch the money

A qualified intermediary (QI) holds the proceeds between the sale and the purchase. The QI has to be in place before your sale closes. If the funds land in your account, the exchange is over.

Buy equal or greater, and reinvest all of it. 

To defer the full tax, the replacement should cost at least as much as the property you sold, and all of your net proceeds should go into it. Cash you keep, or debt you don’t replace, is called boot. Boot is taxable.

Watch the clock

Once your sale closes, you’ll have a strict timeline to complete the exchange. 

• Day 45 (the 45-day rule): Identify your replacement options in writing. The most common approach is the three-property rule: name up to three properties, at any price. Two other rules let you name more. The 200% rule allows any number, as long as their combined value is no more than twice your sale price. The 95% rule has no cap, but you have to close on at least 95% of the total value you named, which makes it hard to use in practice.
• Day 180: Close on the replacement. One catch: if your tax return comes due before day 180, file an extension or the window closes early.

What Happens if You Miss Your 45 Day Deadline?

The exchange fails. The sale is treated as a regular taxable sale, and the tax you planned to defer comes due.

This is where we see the most risk. Forty-five days sounds like plenty until you’re in it. Owners who start looking after the sale closes end up shopping against a deadline, and deadlines push people toward properties they wouldn’t otherwise buy.

That’s why we start the replacement conversation before a building ever goes to market. Through our NEXT™ Program, we define what the replacement needs to do, coordinate with your qualified intermediary before the sale closes, and start sourcing on-market and off-market options through the Marcus & Millichap platform. When the 45-day clock starts, there’s already a plan in place.

Level up your multifamily real estate knowledge with these additional resources from our website:

• How The Neema Group’s 3-Phase Process Makes Multifamily Real Estate Easy
• Who’s Who in Real Estate
• Is Buying An Apartment Complex A Good Investment?

1031 Timeline at a Glance

Start to finish, it’s often the better part of a year.

California Rules

Three California details to walk through with your CPA.

Out of State Exchanges

First, if you exchange into property outside California, the state keeps track of you. You’ll file an annual form with the Franchise Tax Board (Form 3840), and when you eventually sell that out-of-state property in a taxable sale, California collects tax on the gain from your original building.

Property Tax

Second, the exchange defers income tax, not property tax. A California replacement property is reassessed at its purchase price. Your Prop 13 base doesn’t come with you.

ULA

Third, if your building is in the City of Los Angeles, a 1031 doesn’t touch Measure ULA. ULA is a transfer tax, not an income tax, so it applies whether you exchange or not: 4% on sales above roughly $5 million and 5.5% above roughly $10 million, with thresholds adjusted each year. For owners near those lines, it belongs in the math before you list.

Hear from a real property owner who has completed a 1031 exchange and how the process helped them. 

How a 1031 Benefits Owners

The mechanics are the easy part. The harder part is deciding what you want the next chapter to look like.

For a lot of the owners we work with, the answer isn’t always more units. Sometimes it’s less weight. Similar income, fewer calls, less exposure to legislation that keeps changing. That can mean a commercial building in another market, a net lease property where the tenant covers most expenses, or a passive structure like a Delaware Statutory Trust.

1031 Exchange: A Case Study

We recently brought an 18-unit building to market for a family that had owned it for more than 40 years. No debt, no deferred maintenance, no tenant issues. They decided to sell because the regulatory math in Los Angeles no longer fit how they wanted to operate. They’re exchanging into retail out of state, putting the same capital to work where cash flow is more predictable and operations are simpler.

Another family we worked with in West LA sat down with us before listing and walked through the options: different product types, different markets, different levels of involvement. By the time five offers came in, they knew exactly what the money needed to do next. They got to choose the buyer instead of scrambling to figure out the rest.

Explore more of our signature case studies to learn more about our process and the results we’ve achieved for our clients.

Connect With The Neema Group

If you’ve owned in LA for a long time, the exchange is usually the part that works. The question worth sitting with is what you’d want your equity doing if it weren’t tied to this building.

If that question has been on your mind, we’re happy to talk it through.

Need multifamily real estate support? Call (213) 797-2290 or email us at neema@marcusmillichap.com to reach our team of experts.