Trading into something else

An owner with a building they have held for thirty years is usually sitting on a gain large enough that selling outright feels impossible. Federal capital gains, depreciation recapture, California income tax at up to 13.3%, and the net investment income tax can consume a third of the proceeds or more.

A 1031 exchange is the standard answer. It works. But three things about it surprise people, and two of them are specific to Los Angeles.

How the mechanics actually run

You sell the building. You do not touch the money — a qualified intermediary holds it, and constructive receipt blows the exchange. Then two clocks run simultaneously from the day you close:

• 45 days to identify replacement property, in writing, following the identification rules.
• 180 days to close on it — or the due date of your tax return for that year, whichever comes first.

That second clause is the one that bites. Close a sale in November and your 180 days runs past the April filing deadline, which means the window collapses unless you file an extension. Anyone selling in the fourth quarter needs to plan the extension before the sale, not after.

Like-kind is broad. Since 2017, section 1031 applies only to real property, but within real property the definition is generous. The IRS puts it plainly: real properties are generally of like-kind regardless of whether they are improved or unimproved. An LA fourplex can exchange into raw land, a strip center, a medical office building, or a fractional interest in a larger institutional property through a Delaware Statutory Trust. What it cannot do is exchange into property outside the United States.

Boot is taxable, and mortgage relief counts. Anything you receive that is not like-kind property triggers gain to that extent. Cash is obvious. Less obvious: if you sell a building with a $2 million loan and buy one with a $1.4 million loan, that $600,000 of debt relief is boot even though you never saw a dollar.

The practical rule most people use: to fully defer, buy equal or greater in value, reinvest all the equity, and take on equal or greater debt.

Measure ULA does not care about your exchange

This is the first LA-specific problem, and it is the one owners are least prepared for.

A 1031 exchange defers income tax. Measure ULA is a transfer tax on the gross sale price. To our knowledge, deferring the income tax does nothing at all to the transfer tax — you owe it on the way out regardless of where the proceeds go. The LA Office of Finance's published FAQ does not address 1031 exchanges, so confirm this directly before relying on it, but plan on paying.

As of July 1, 2026:

Thresholds adjust each July 1. On a $6,000,000 exchange out of a City of LA building, roughly $267,000 leaves before the intermediary ever sees the money. That materially changes what you can buy, and it has to be in the model from the first conversation.

It also changes the strategic question. For an owner above the threshold, ULA raises the cost of every exit — sale or exchange — which pushes some owners toward refinancing and holding instead. That is not a tax dodge; it is just the arithmetic pointing somewhere else.

Watch AB 736, which would cap local transfer taxes at 1.5% starting January 1, 2027. It sat in committee as of mid-2026 and has not passed. We would not delay a transaction on the chance it does, but an owner already planning a 2027 sale should track it.

California follows you

The second surprise. If you exchange California property into property in another state, California does not forget.

You must file FTB Form 3840 for the year of the exchange and every year after, until the deferred California-source gain is finally recognized. The obligation applies to all taxpayers regardless of residency — moving to Nevada or Texas does not end it.

When you eventually sell the out-of-state replacement property in a taxable transaction, the California-source gain becomes taxable to California, even if you have not lived there for a decade. Stop filing the annual form and the FTB can issue a proposed assessment with penalties and interest.

Plenty of people have exchanged an LA building into Arizona or Texas, relocated, and quietly assumed they were finished with California. They are not, and the reckoning arrives years later.

The alternative nobody mentions: don't sell at all

Worth putting on the table, because for some owners it is the best answer.

Under Internal Revenue Code section 1014, property passing at death receives a stepped-up basis equal to fair market value on the date of death. All the deferred gain — including gain carried forward through a chain of 1031 exchanges — is eliminated. Heirs take the property at today's value with no income tax on the appreciation.

California adds something better. Because California is a community property state, when one spouse dies, both halves of community property receive a new basis, not just the decedent's half. In separate-property states only half steps up.

This is why "swap till you drop" is a real strategy and not a joke. Each exchange defers; death forgives. For an owner in their seventies with a low-basis building and no need for the cash, an exchange into something lower-maintenance — or simply holding — can beat any sale.

The counterweight is Proposition 19, which reassesses that same property for property tax purposes when it passes to children. The income tax basis steps up and the property tax basis resets, in opposite directions, for different reasons. That collision is the subject of our note on succession planning.

Is 1031 itself at risk?

Owners ask this every year because it gets proposed for repeal or limitation regularly.

As of September 2026, no enacted or pending federal legislation modifies section 1031. The 2025 tax act made no changes to it. Prior administration budget proposals to cap deferral were never enacted.

We would not describe that as permanent safety. It is a recurring target. But there is nothing to plan around right now.

What we actually do

Before anyone calls a broker, we run three numbers side by side: sell outright and pay the tax, exchange and defer it, or refinance and hold.

The exchange number has to include the transfer tax, the intermediary's fee, the cost of replacement property in a market where you are on a 45-day clock and everyone knows it, and an honest view of whether the replacement actually produces better risk-adjusted income than what you already own.

That last one is where exchanges go wrong. The clock creates pressure to buy something, and something is not always better than the building you know. We have told owners to pay the tax. Sometimes it is the right answer.

This is general information, not tax advice. Exchange mechanics are unforgiving and the deadlines cannot be extended. Engage a qualified intermediary and your CPA before you list.

Sources

• IRS, Like-Kind Exchanges - Real Estate Tax Tips
• Internal Revenue Code section 1031
• California FTB, Form 3840 instructions
• LA Office of Finance, Measure ULA FAQ
• Internal Revenue Code section 1014, basis of property acquired from a decedent