California state law differs from federal law in regard to the tax treatment of tax-deferred exchanges in some instances.

CA law conforms to Sec. 1031 as it existed prior to TCJA, R&TC Sec. 18031 and 24941. Thus, except as noted below, CA will not follow the TCJA change to Sec. 1031 and vehicles and other non-real estate property would be eligible to receive tax-deferred exchange treatment for CA but not federal. California conforms to Federal computations. However, watch for differences in basis.

The TCJA provision that limits Sec. 1031 treatment only to exchanges of real property was adopted by California in AB 91 (signed by the governor 6/27/2019), with two significant differences:

The replacement property in a qualified exchange may be located outside of California. If the out-of-state property is later sold in a taxable transaction at a time when the taxpayer is a California resident, any gain is taxable to California. Further, if the taxpayer who was a California resident when the exchange to out-of-state property took place sells the out-of-state property while a non-resident of California, the previously unrecognized gain is taxable to California.    

Effective for exchanges on or after January 1, 2014 if a gain or loss from the exchange of property in California is deferred under IRC Section 1031, and the property acquired in that exchange is located outside of California, the taxpayer – whether a resident or non-resident – shall file an information return with the Franchise Tax Board for the taxable year of the exchange and for each subsequent taxable year - in which the gain or loss from that exchange has not been recognized. (AB 92 6/27/13; R&TC Sec 18032 and 24953) Taxpayers who exchange only personal property assets are not subject to this requirement. (2021 instructions to FTB 3840)

Form FTB 3840 is a comprehensive 2-page form used for this purpose and is attached to the taxpayer’s CA return. However, a taxpayer not otherwise required to file a California return must complete the entire form FTB 3840, including the signature section, and file the form, by the due date for the type of return that they would have filed if one were required, at the following address: Franchise Tax Board, PO Box 1998, Rancho Cordova, Ca 95471-1998.

For taxpayers who fail to comply with the reporting requirement, FTB could make a return based on an estimate of the net income from the exchange and may issue an assessment including tax, interest, and penalties due in the same manner as assessments that are proposed for the failure to file a return. See the instructions to FTB 3840 for additional information.

In a unanimous and formal opinion, the State Board of Equalization granted the appeal of a group of taxpayers who had tenant-in-common interests in an apartment building that they exchanged for a shopping mall and surrounding property and ruled that there had been a qualified 1031 exchange even though, within a few months, the owners transferred the property to an LLC. “The foregoing record demonstrates that appellants conducted a valid exchange under IRC section 1031, notwithstanding the subsequent change in form of ownership, because the exchange was properly executed, the replacement property was held for investment purposes, and the step transaction doctrine does not apply to disregard appellants’ acquisition of the replacement property.” The taxpayer-favorable ruling made it clear that a plan to transfer property acquired in an exchange to a different form of holding does not disqualify the exchange as long as the taxpayer retains his or her investment in the property. (Appeal of Rago Development Corp. et al. (June 23, 2015) 2015-SBE-001)

Generally, no income tax withholding on a like-kind exchange is required with proper seller certification. However, if boot in excess of $1,500 is received by the seller, withholding is required. If the transaction fails to meet all of the IRC Sec. 1031 requirements (for example, the 45- or 180-day test is failed), then the intermediary or accommodator must withhold at 3 1/3% of the full sales price. (2021 FTB Form 593 Instructions)