Is a 1031 exchange worth it, or should you just pay the tax?
Sometimes the answer is no.
Most pages ranking on this question are published by companies paid to run exchanges, and they all reach the same conclusion, because for them it always is the right answer. It is not always right for you. Sometimes writing the check beats a rushed exchange into a property you did not want. Sometimes paying costs you a third of your equity for no reason.
The difference is arithmetic, not opinion. Below is that arithmetic, run both directions on a realistic Sacramento number, plus the cases where paying wins. Matt Bingaman is a Commercial Advisor, not a CPA and not a qualified intermediary, so none of this is tax advice for your situation.
You are not deciding about the tax. You are deciding about the next property.
A 1031 exchange does not eliminate tax. It defers it. Section 1031 lets you roll the gain from one investment property into another without recognizing it, and your basis carries forward, so the deferred gain stays attached to the new property. Sell that one for cash in six years and the whole thing comes due.
So an exchange is not a tax strategy in isolation. It is a financing decision. Deferring puts the government’s share to work in the next building instead of sending it in. That is the entire benefit. If you do not want the next building, the benefit is zero and the exchange is an expensive delay on a bill you will pay anyway.
The honest first question is not how do I avoid the tax. It is this: do you actually want to own more real estate?
What the tax bill actually is in California.
Four layers stack, and most owners underestimate the total because they think about only the first.
- Federal long-term capital gains. For tax year 2026 the 20% rate applies to taxable income above $545,500 single and $613,700 married filing jointly. Those figures come straight from the IRS annual inflation adjustment, Revenue Procedure 2025-32. A meaningful commercial gain lands you there.
- Depreciation recapture at 25%. Every dollar of depreciation you claimed gets pulled back out and taxed at up to 25% under the unrecaptured Section 1250 rules. This is the layer people forget. On a fifteen-year hold, recapture can be a quarter million dollars taxed higher than the appreciation.
- Net investment income tax of 3.8%. Applies once modified AGI passes $200,000 single or $250,000 joint. Those thresholds are set by statute, are not indexed, and have not moved since 2013, so a sale gain almost always crosses them.
- California, the layer that changes the math. California has no preferential capital gains rate. None. Your gain is taxed as ordinary income on the same brackets as your salary, topping out at 12.3%.
You will see 13.3% quoted, including elsewhere on this site, and both numbers are right depending on what is being described. 12.3% is the top marginal bracket. The extra 1% is a separate surcharge applying only to California taxable income above $1,000,000. Proposition 63 created it in 2004 as the Mental Health Services Tax. Proposition 1 restructured it in March 2024, and the Franchise Tax Board now calls it the Behavioral Health Services Tax, on Form 540, line 62. The name changed. The mechanics did not. It is still assessed only on the portion above the million. An owner with $1.2 million of California taxable income pays 1% on $200,000, which is $2,000, not on the full amount.
Practically: if your gain plus other income clears $1 million, plan around 13.3% at the top of the stack. If it does not, 12.3% is your ceiling, and your blended rate is lower still, because the lower brackets fill first.
One more item, because it catches people who move away. Exchange into replacement property outside California and the state tracks the deferred gain permanently, with an annual filing required. See our California 1031 clawback and FTB Form 3840 pages.
What the exchange actually costs.
The fee is the small part. The constraint is the expensive part.
The intermediary fee is noise
Qualified intermediary fees for a standard delayed exchange run about $750 to $1,500, most institutional firms between $800 and $1,200, plus roughly $250 to $500 per replacement property identified beyond the first. Reverse and improvement exchanges run $3,000 to $10,000 or more. On a seven-figure gain, a $1,200 fee is noise. Do not let anyone talk you out of an exchange over the fee, or into one because the fee is small.
The clock is the real cost
The 45-day identification window and the 180-day closing window are what you are actually paying. From the day your sale closes you have 45 calendar days to identify replacement property in writing and 180 days to close. No extension for a bad market, a failed inspection, or a seller who will not perform. Miss either date and the exchange fails, with tax due on the original sale.
The clock makes buyers overpay
What that deadline does to buyers is easy to observe in any cycle: it makes them pay more. When a buyer must close by a fixed date or eat a six-figure tax bill, leverage transfers to the seller, and sellers who know they are dealing with exchange money price accordingly. Overpay 5% on a $2.5 million replacement property and that is $125,000, most of a year’s deferral benefit gone on day one.
The fix is sequencing. Start identifying replacement property before you list, not after you close. The 1031 exchange hub walks the timeline, and the Sacramento, Folsom, and Roseville pages cover replacement inventory by submarket.
The same building, run both ways.
A realistic Elk Grove scenario. A multi-tenant retail building bought in 2011 for $1,400,000, with $400,000 of depreciation claimed, so adjusted basis is $1,000,000. It sells in 2026 for $2,600,000 with 5% selling costs. The owners file jointly with $150,000 of other taxable income, and there is no debt on the property.
| Line | Amount | How it gets there |
|---|---|---|
| Sale price | $2,600,000 | Contract price |
| Less selling costs, 5% | ($130,000) | Commissions, escrow, title |
| Amount realized | $2,470,000 | $2,600,000 less $130,000 |
| Less adjusted basis | ($1,000,000) | $1,400,000 cost less $400,000 depreciation |
| Total taxable gain | $1,470,000 | $2,470,000 less $1,000,000 |
| Depreciation recapture at 25% | $100,000 | 25% of the $400,000 depreciation slice |
| Federal capital gains at 20% | $214,000 | 20% of the remaining $1,070,000 |
| Net investment income tax at 3.8% | $55,860 | 3.8% of $1,470,000 |
| California income tax, blended | $160,300 | 2025 FTB married filing jointly schedule, the added tax the gain causes, plus the 1% surcharge on income above $1,000,000. Roughly 10.9% blended, 13.3% at the margin |
| Total tax if you pay it | $530,160 | 36.1% of the gain |
| Cash to reinvest after paying | $1,939,840 | $2,470,000 less $530,160 |
| Cash to reinvest via exchange | $2,468,800 | $2,470,000 less a $1,200 intermediary fee |
| Buying power preserved | $528,960 | $2,468,800 less $1,939,840 |
The exchange preserves about $528,960 more buying power, roughly 27% more equity working. At 60% loan to value, that is the difference between chasing a $4.8 million replacement property and a $6.2 million one. And if that deferred $530,160 earns 6% net for ten years, it produces roughly $419,000 of value that would not otherwise exist.
Note the California line. At 12.3% flat it would read $180,810. The blended figure is lower because the lower brackets fill first, and it moves with your other income. California indexes its brackets every year and has not published a 2026 schedule yet, so this uses the 2025 married filing jointly schedule, which is what the Franchise Tax Board’s own 2026 estimated tax instructions tell you to use. That one line can swing $30,000 on facts only your CPA has. Price this off your own return, not off this table.
When paying the tax is the better move.
Five situations, more common than the exchange industry admits.
The gain is small
Below roughly $150,000 of gain, the fixed costs and the constraint outweigh the benefit. You still pay the intermediary fee, still lose negotiating leverage for 180 days, and still take on a replacement property you may not want, to defer perhaps $45,000. If deferring $45,000 means overpaying $60,000 under time pressure, you lost.
You have losses to absorb the gain
The most underused answer on this list. If you have capital losses carried forward, or suspended passive activity losses trapped on this property from years of paper losses you could not deduct, a fully taxable sale in a qualifying complete disposition releases them to offset the gain. Owners have found $200,000 of suspended losses sitting there and realized they could have sold nearly tax free, after already exchanging and locking those losses up for another cycle. Ask your CPA to pull your suspended passive loss carryforward before you decide anything. That one number flips more of these decisions than any other.
You want out of real estate
If you are honestly done, an exchange does not serve you. It buys another building you do not want, on a 180-day clock, and the tax still arrives eventually. Delaware Statutory Trusts are the usual answer here and they are legitimate replacement property, but they are illiquid, you give up control, and the sponsor takes fees. That can be right. It can also be a way to dodge a tax bill by handing your equity to someone else for a decade.
Estate planning makes waiting the better play
Under current law, appreciated property held until death gets a step-up in basis to fair market value and the deferred income tax on the appreciation is erased. Swap till you drop is real, and for an older owner with no intention of selling for cash, deferral is close to permanent. But that argues for holding, not for a rushed exchange today, and it helps your heirs, not you. If you need the cash in your lifetime, the step-up is not part of your math.
The replacement property is not there
The one an advisor sees most and clients hear least. If nothing in your submarket at your price and return threshold is available in the next 45 days, the exchange is not a strategy, it is a bet on inventory appearing. A 36% tax bill on a good decision beats a 0% tax bill on a bad building.
How to get a real answer in the next two weeks.
Three calls, in this order, before you list anything.
Your CPA, first
Ask for four numbers: adjusted basis, total depreciation claimed, suspended passive loss carryforward, and estimated total tax on a fully taxable sale including recapture, the net investment income tax, and California. Nobody can advise you without those four, and nobody but your CPA can produce them.
A qualified intermediary, second
Confirm the fee structure and that they hold funds in a segregated qualified escrow account. This must be arranged before closing. Once sale proceeds touch your hands, the exchange is dead.
An advisor who knows the inventory, third
Whether property meeting your criteria exists right now is a market question, not a tax question. Start with investment sales, then the market guide that matches where you are selling.
If the tax number is small, or losses cover it, or you are done owning, pay it. If it is large and you want the next property, run the exchange, and start identifying replacements before you list. The expensive version is deciding in week three of the 45.
Questions people actually ask.
Yes, and the cash you take is taxable. Proceeds you receive rather than reinvest are called boot, and boot is taxed, generally hitting your depreciation recapture first at 25%. A partial exchange is legitimate and common. Just know the cash you pull is taxed at close to the worst rate available, not the best. Have your CPA model the split before you commit to an amount.
There is no threshold in the code, only in the arithmetic. As a working rule, below roughly $150,000 of gain the fixed costs and the 180-day constraint tend to outweigh the deferral. Above roughly $300,000 the deferral usually dominates, unless you have losses to absorb the gain or you want out of real estate.
No, and this is the most consequential difference from federal treatment. California has no preferential capital gains rate. Your gain is taxed as ordinary income at rates up to 12.3%, plus a 1% surcharge on California taxable income above $1,000,000, which is where the commonly quoted 13.3% comes from. The Franchise Tax Board calls that 1% the Behavioral Health Services Tax on Form 540, line 62. It applies only to the portion above the million.
The exchange fails and the sale becomes fully taxable in the year it closed. There are no extensions for market conditions, financing problems, or a seller who does not perform. The IRS has granted relief in federally declared disaster areas, but that is not something to plan around. The 45 days are calendar days.
Yes. Both must be held for investment or productive use in a trade or business, but they do not need to be the same type of property. Residential rental into retail, office, industrial, or land all qualify. Trading tenant management for a single-tenant net lease building is one of the most common reasons Sacramento-area owners run an exchange at all.
Under current law, holding until death gives your heirs a stepped-up basis at fair market value and wipes out the deferred income tax on the appreciation. That is genuinely powerful, and it is why swap till you drop exists. It also means you never see the cash. If you need liquidity in your lifetime, it is not your plan. Work it through with your CPA and an estate attorney together.
Ready to run the numbers on your property?
Fifteen minutes, no pitch. We look at your basis, your timeline, and whether realistic replacement inventory exists in your price range. If paying the tax is your better move, Matt will tell you.
1031 exchange overview | Sacramento | Folsom | Roseville | El Dorado Hills | Placerville | California clawback | FTB Form 3840 | Selling a rental property | Contact
This page is general information and education only. It is not tax, legal, or accounting advice, and it cannot be relied upon as such. Matt Bingaman is a licensed California real estate salesperson, not a CPA, an attorney, or a qualified intermediary. Tax rules change and outcomes depend entirely on your individual facts. Consult your own tax advisor before acting on any of it.