Thinking about selling a Redwood City rental but worried about a big tax bill? You are not alone. Many Peninsula landlords sit on sizable gains and want a smart way to reinvest without losing momentum to taxes. In this guide, you will learn how a 1031 exchange works, what California requires, and the local factors that can make or break your plan. Let’s dive in.
1031 exchange basics
A 1031 exchange lets you defer tax when you sell investment or business real estate and buy other like-kind real estate. It applies to real property only, and the tax is deferred, not erased. You must report the exchange on IRS Form 8824 and follow strict rules, including using a qualified intermediary to hold proceeds. You can review the core mechanics in the IRS instructions for Form 8824.
Timing rules you must hit
You have 45 days after you transfer the old property to identify replacements and 180 days to close on them. These deadlines are statutory and rarely extended. The IRS details identification options like the three-property and 200% rules in the Form 8824 instructions.
What is and isn’t deferred
If you reinvest all proceeds and replace any debt with equal or greater financing, you can defer capital gain. If you receive cash or other non-like-kind property, that “boot” is taxed to the extent received. Prior depreciation is not erased, and unrecaptured Section 1250 gain can be taxed when recognized, as explained in IRS Publication 544.
California-specific rules
California generally conforms to federal 1031 rules for real property, but the state has its own reporting steps. Cross-state exchanges often require additional state reporting, so do not rely on federal filing alone. Review the Franchise Tax Board’s guidance on reporting like-kind exchanges and Form 3840 at the FTB’s exchange page.
California taxes capital gains as ordinary income for state purposes, so the combined federal long-term capital gains rate, possible 3.8% NIIT, and California income tax can be material. Compare “pay now” versus “defer via 1031” with current federal rate ranges, summarized by NerdWallet’s capital gains overview.
Redwood City market factors
Redwood City values and rents are among the higher levels in the Bay Area. Many long-held rentals here carry large unrealized gains, which makes tax deferral attractive when you sell and reinvest. Inventory can be tight, so lining up replacement options early helps you stay within the 45 and 180 day windows.
Local costs matter too. San Mateo County property tax is typically near 1% of assessed value, plus local assessments and bonds, which affect carrying costs and pro-rations at closing. You can review county-level details on San Mateo County property tax. Also watch city-level policy changes. Redwood City has discussed a possible real property transfer tax in recent local coverage, which would increase transaction costs if adopted. See this local discussion on a potential transfer tax in Redwood City Pulse.
When a 1031 fits
- You have a large unrealized gain and want to redeploy equity while deferring tax.
- You plan to upgrade or reposition, for example trading single-family rentals into multifamily or commercial holdings.
- You want to exchange a Redwood City asset for a property in another market, which is permitted under federal rules when properly structured and reported on Form 8824.
When a 1031 may not fit
- Your taxable gain is small, so fees and complexity outweigh benefits.
- You need liquidity or flexibility and do not want capital locked in a property or a passive vehicle.
- You intend a short hold or a quick conversion to personal use. Conversions and the principal-residence rules have special timing and depreciation recapture issues described in Publication 544.
Replacement options to consider
- Buy locally or within the broader Bay Area if inventory and pricing align with your goals.
- Use a reverse exchange when you need to acquire first, structured through a Qualified Exchange Accommodation Arrangement. Learn the basics of a QEAA.
- Consider a Delaware Statutory Trust to access institutional real estate without direct management. The IRS addressed DSTs in Rev. Rul. 2004-86, summarized in the Internal Revenue Bulletin. DSTs can be illiquid and carry sponsor risk, as explained in this overview of DST risks.
Your Redwood City 1031 checklist
- Run the numbers: model “sell and pay tax” versus “defer via 1031,” including federal LTCG, possible 3.8% NIIT, California income tax, and unrecaptured Section 1250. See federal rate ranges in this overview.
- Engage a qualified intermediary early, before your sale closes, and confirm identification rules in the Form 8824 instructions.
- Line up replacements early given local inventory. If timing is tight, review reverse exchanges and QEAAs at a high level on Investopedia.
- If you consider DSTs, read the IRS background in the IRB entry and practical risk notes from Kiplinger.
- Coordinate filings: file Form 8824 federally, and follow California reporting if your exchange crosses state lines at the FTB’s page.
- Budget closing costs and taxes: include escrow, title, potential city transfer taxes under discussion, and county property taxes using San Mateo County references.
- Protect financing: match or increase your debt on the replacement to avoid taxable boot.
The bottom line
A 1031 exchange can be a powerful tool for Redwood City rental investors, especially when you have significant appreciation and a clear reinvestment plan. Success comes from early planning, tight timeline control, and realistic replacement options. With an integrated brokerage and property management partner, you can sell, acquire, lease, and oversee your assets under one roof.
If you want a local, step-by-step game plan tailored to your portfolio, connect with Manie Kohn for a conversation about your options.
FAQs
What is a 1031 exchange for rental property?
- It is a tax-deferred swap of investment or business real estate for other like-kind real estate, reported on IRS Form 8824, where you follow strict identification and closing timelines.
How do the 45-day and 180-day deadlines work?
- You must identify replacement property within 45 days of transferring your old property and close within 180 days, with limited exceptions outlined by the IRS in the Form 8824 instructions.
Does California honor 1031 exchanges for real property?
- Generally yes, but you must follow state reporting rules, including possible Form 3840 for cross-state exchanges, per the FTB’s guidance.
Can I exchange a Redwood City property for one in another state?
- Yes, federal rules allow cross-state exchanges when properly structured and reported on Form 8824, and California may require additional reporting.
What happens if I receive cash boot during the exchange?
- Cash or other non-like-kind property received is taxable to the extent of the boot, and prior depreciation may be subject to recapture later, as outlined in IRS Publication 544.
Are Delaware Statutory Trusts a good replacement option?
- DSTs can simplify management and help you meet timelines, but they are generally illiquid and carry sponsor and structure-specific risks. See the IRS background in the IRB entry and this summary of DST risks.
