Selling California Property and Buying Out of State? California May Still Follow the Deal

A lot of California investors have the same idea:

Sell a California property, complete a 1031 exchange, and buy something simpler out of state — maybe a triple-net property.

That can work.

But there are still two California concepts to keep in mind.

1. California may keep tracking the deferred gain

Even if the exchange is valid for federal tax purposes, California may still want to track the gain if you sold California property and bought replacement property outside California.

That is what FTB Form 3840 is about.

The basic idea is simple: the gain started with California property, so California may still want to keep track of it until that gain is ultimately recognized.

So even if your replacement property is in another state, California may not be fully out of the picture.

2. If you keep the California LLC, you may keep the California LLC tax

A second issue is the entity itself.

If the replacement property is still being held in the same California LLC, that California LLC may continue to carry California obligations.

So the property may leave California, but the California LLC may still keep one foot in California.

Bottom line

If you exchange California property into out-of-state property, the move out of California may be real from an investment standpoint.

But California may still matter in two ways:

• California may keep tracking the deferred gain.
• The California LLC may keep generating California annual tax obligations.

That does not necessarily mean the exchange is a bad idea.

It just means “leaving California” is not always as clean as it sounds.