Selling an investment property in Redwood City can create a tax bill that takes a big bite out of your gains. With local sale prices still at Bay Area levels, even long‑held rentals can trigger significant capital gains and depreciation recapture. The good news: a properly executed 1031 exchange can defer those taxes so more of your equity stays invested and working for you. This guide breaks down what a 1031 exchange is, the key deadlines, California rules, and practical strategies for Peninsula investors. Let’s dive in.
What a 1031 exchange actually does
A 1031 exchange lets you defer recognition of gain when you sell real property held for investment or business and buy other like‑kind real property. The tax is deferred, not eliminated, and you report the exchange to the IRS. You must follow strict rules for identification, timing, and handling of funds to qualify. See the IRS overview of like‑kind exchanges for the core framework and definitions.
Why this matters in Redwood City
- High values: Median sale prices in Redwood City hover around the multimillion range, which means realized gains can be large when you sell. Deferring those taxes preserves capital for your next purchase.
- Rental demand: Recent reports show strong upward pressure on Peninsula rents, which can support cash flow on replacement properties you acquire through an exchange. See coverage of recent rent spikes in nearby suburbs for context. SFGATE on rising Peninsula rents
- Ongoing costs: Property tax rates in San Mateo County typically land near the low‑1 percent range of assessed value, plus local assessments. This affects your rental pro forma when you evaluate replacement properties. San Mateo County property tax reference
The rules you must hit
Eligible property
Your relinquished and replacement properties must be real property held for investment or for use in a trade or business. U.S. real property is not like‑kind to foreign real property. IRS overview
45‑day and 180‑day deadlines
- Identify replacement property in writing within 45 days after you transfer the relinquished property.
- Close on the replacement property within 180 days of the sale or by your tax return due date, whichever comes first.
Missing either deadline generally disqualifies the exchange. IRS Form 8824 instructions
Use a qualified intermediary
To avoid constructive receipt of funds, a qualified intermediary (QI) must hold the proceeds and facilitate the exchange. Engage the QI before you close on the sale. IRS Form 8824 instructions
Identification rules
Use one of the IRS safe harbors to list potential replacements in writing: the three‑property rule, the 200 percent rule, or the 95 percent exception. Follow format and timing precisely. IRS Form 8824 instructions
Boot and debt replacement
Cash received or a reduction in liabilities you do not replace is taxable boot. To fully defer gain, buy equal or greater value and replace equal or greater debt. IRS overview
Reporting
File Form 8824 with your federal return to report the exchange. Keep detailed records of dates, identification notices, contracts, and settlement statements. IRS Form 8824 instructions
What to plan for on taxes
Federal capital gains and recapture
A valid 1031 defers both long‑term capital gains and depreciation recapture. When you later sell the replacement property without another exchange, you recognize the deferred amounts. Unrecaptured Section 1250 gain tied to prior depreciation can be taxed up to 25 percent, and high earners may also owe the 3.8 percent Net Investment Income Tax. IRS Publication 544
California conformity and extra filings
California generally conforms to 1031 for real property. If you exchange a California property into an out‑of‑state replacement, you must file FTB Form 3840 each year until the deferred California‑source gain is recognized. California taxes capital gains at ordinary income rates, which can run high at upper brackets. Review FTB guidance before you start. FTB guidance on like‑kind exchanges and Form 3840
Practical strategies for Peninsula investors
- Scale up: Trade into larger multifamily or small commercial assets to match or exceed your sales proceeds and avoid boot.
- Diversify: Use the three‑property or 200 percent identification rules to acquire multiple rentals across cities or submarkets. IRS identification rules
- Consider fractional options: Delaware Statutory Trusts (DSTs) and some tenants‑in‑common structures can qualify as replacement property. Evaluate sponsor strength, fees, liquidity, and exit provisions carefully, including the risk of forced conversions that can affect future 1031 planning. DST risks to understand
- Bridge timing with advanced structures: Reverse or improvement exchanges use special arrangements and add complexity. Plan early if speed or construction is required. What a QEAA is and how it works
A step‑by‑step pre‑sale checklist
- Confirm your use: Ensure the property is held for investment or business and not dealer inventory. IRS overview
- Build your team: Select a reputable qualified intermediary with segregated accounts and strong controls. Verify fidelity coverage and references. How to vet a QI
- Model your taxes: Estimate federal capital gains, depreciation recapture, the 3.8 percent NIIT if applicable, and California income tax to quantify the value of deferral. IRS Publication 544
- Map the timeline: Pre‑identify candidates, confirm lending terms, and set reminders for the 45‑day and 180‑day milestones. IRS Form 8824 instructions
- Decide on structure: Direct replacements, multiple properties, DST or a reverse/improvement exchange each carry different timing, risk, and management tradeoffs. QEAA overview
- Prep for California filings: If buying out of state, plan for annual FTB 3840 reporting of deferred California‑source gain. FTB guidance
Common pitfalls to avoid
- Waiting to hire the QI until after closing. At that point the exchange often fails due to constructive receipt of funds.
- Missing the 45‑day identification window or using an identification that does not meet the written safe harbor.
- Under‑buying value or not replacing debt, which creates taxable boot.
- Ignoring California’s ongoing filing requirements after moving equity out of state.
- Overlooking DST sponsor risks, liquidity limits, or exit constraints before investing.
How we help Redwood City investors
You need a local team that can move fast, source qualified replacements, and keep your exchange on schedule. With more than 30 years of Mid‑Peninsula experience, our boutique brokerage and in‑house property management make it easier to go from sale to tenant‑ready purchase without losing time. We help you plan the 45‑ and 180‑day milestones, coordinate with your QI, and line up lending, inspections, and rent‑ready work so cash flow starts sooner.
If you are weighing direct acquisition versus multiple properties or a DST, we will walk you through the local inventory, rental comps, and management implications so your next move matches your risk and income goals. You bring your CPA or tax attorney for modeling and filings. We bring neighborhood expertise, leasing know‑how, and accountable property management to protect your investment long term.
Ready to explore a 1031 exchange in Redwood City and keep more of your capital working for you? Connect with Manie Kohn to map your options and a timeline that fits your goals.
FAQs
What is a 1031 exchange in simple terms?
- It is a federal mechanism that lets you sell investment or business real estate and buy other like‑kind real estate while deferring capital gains and depreciation recapture, if you follow strict rules. IRS overview
What are the 45‑day and 180‑day rules for 1031s?
- You must identify replacement property in writing within 45 days of selling your property and close on your replacement within 180 days or by your tax return due date, whichever is earlier. IRS Form 8824 instructions
How does California treat 1031 exchanges for Redwood City owners?
- California generally conforms for real property, but if you buy out of state, you must file FTB Form 3840 each year until you recognize the deferred California‑source gain. FTB guidance
What is taxable boot in a 1031 exchange?
- Boot is cash or non‑like‑kind value you receive, or a reduction in debt you do not replace. Boot is taxable to the extent of gain. IRS overview
Can I use a DST as 1031 replacement property?
- Many investors use DST interests to complete an exchange, but you should assess sponsor quality, fees, liquidity, and exit terms, including the risk of forced conversions that complicate future exchanges. DST risk primer
