Thinking about selling an investment property in the Palisades and deferring taxes? A 1031 exchange can keep more of your capital working, but the rules are strict and the timelines are unforgiving. You also need to account for California’s extra filings and Los Angeles regulations that affect how you can use a replacement property. This guide walks you through the essentials, local nuances, and smart steps to take before you list. Let’s dive in.
What a 1031 exchange does
A 1031 exchange lets you defer federal capital gains tax when you exchange real property held for investment or business use for other like-kind real property. For real estate, most U.S. properties are considered like-kind to other U.S. properties. Personal property no longer qualifies. Review the IRS overview of like-kind exchanges to understand what qualifies and how deferral works under current law.
According to the IRS, property held primarily for sale does not qualify, and replacement property must also be held for investment or business use. You report the exchange on IRS Form 8824 for the year the exchange begins. For details on reporting and definitions, see the IRS Form 8824 instructions.
- IRS overview: Like-kind exchanges, real estate tax tips
- IRS rules and reporting: Form 8824 instructions
Key rules and deadlines you must hit
Like-kind and use tests
Most U.S. real property can exchange into other U.S. real property. The properties must be held for investment or productive use in a trade or business. A primary residence or property held for personal use typically does not qualify. See the IRS instructions for definitions and examples.
45-day identification and 180-day closing
You have 45 calendar days from the date you close on your sale to identify replacement properties in writing, and 180 days to close on the replacement. These deadlines are hard and rarely waived. The IRS may grant limited disaster relief in declared events, but you should confirm eligibility before relying on extensions.
Keep sale proceeds out of your hands
Use a Qualified Intermediary to hold the funds so you do not receive or control the proceeds. If you or a disqualified party takes receipt, even briefly, the exchange can be disallowed. The IRS highlights the importance of a properly structured QI arrangement in delayed exchanges.
Know how “boot” and basis work
Cash you receive or non-like property is called boot and is taxable to that extent. Your basis generally carries over to the replacement property, adjusted for any recognized gain or boot. You must still address depreciation recapture on a future sale. The IRS Form 8824 instructions explain these mechanics.
California and Los Angeles rules that matter
California conformity and FTB 3840
California generally conforms to federal Section 1031 for real property. If you exchange California property into out-of-state property, you must file California’s Form FTB 3840 to report deferred California-source gain, often annually until you recognize it. Review the state’s guidance on reporting like-kind exchanges.
- State guidance: California reporting like-kind exchanges and FTB 3840
Entity planning and “drop-and-swap” scrutiny
If you plan to restructure ownership interests before or after an exchange, know that the Franchise Tax Board has scrutinized partner and entity arrangements. Results vary by facts, and audit risk is real, so involve tax counsel before you change ownership structures.
- Background reading: California 1031 exchange scoreboard and FTB scrutiny
Los Angeles rental and short-term rules
If your replacement property will be a rental inside Los Angeles city limits, confirm whether it is covered by the Rent Stabilization Ordinance. RSO properties, generally those first built on or before October 1, 1978, have limits on rent increases and specific eviction rules. Also, Los Angeles permits short-term rentals only in an owner’s primary residence under the Home-Sharing Ordinance, and many RSO units are not eligible.
- RSO overview: LA Housing Department guidance
- Short-term rental rules: City of Los Angeles Home-Sharing program
Wildfire deadline relief in 2025
For the January 2025 Los Angeles wildfires, the IRS announced relief for affected taxpayers. If your 45-day or 180-day deadline falls between January 7, 2025 and October 15, 2025, it may be postponed to October 15, 2025. Confirm eligibility with your CPA before you rely on this extension.
- IRS relief notice: IRS Los Angeles County disaster relief update
Palisades market context for replacements
Pacific Palisades is a high-value, primarily single-family coastal area with limited multifamily stock compared with denser Los Angeles neighborhoods. After recent wildfires, some parcels and rebuild opportunities have drawn investor interest. If you are targeting a lot or a rebuild, plan for coastal, planning, and fire-safety considerations that can affect timelines and costs.
Exchanging from a high-cap rental into a luxury single-family home may change your cash flow, management needs, and exit options. A 1031 defers tax, but it does not change the property’s economics or local rules, including RSO and short-term rental restrictions. Match your replacement to your income targets, risk tolerance, and hold period.
- Context on rebuild and timing: Exchange accommodation and reverse structures overview
Step-by-step: how to execute a 1031 in the Palisades
Pre-sale tax planning. Meet with your CPA or tax attorney before you list. Confirm that your property qualifies, estimate deferred gain, and decide whether to pursue full or partial deferral. Ask if California Form FTB 3840 will apply given your replacement location. Review: California reporting like-kind exchanges.
Engage a Qualified Intermediary early. Vet experience, bonding, insurance, trust accounting, and independence. A QI that is too closely related to you can be disqualified. Learn what a QI does here: Qualified intermediary overview.
Align contracts and escrow. Add cooperation language to your sale and purchase agreements. Instruct escrow to send proceeds to the QI and to follow exchange procedures. Confirm your closer understands 1031 processes.
Identify and choose replacements. Deliver written identification within 45 days and close within 180 days. Follow the three-property or 200 percent identification rules as advised by your QI. See timing in the Form 8824 instructions. If you were affected by the 2025 fires, confirm disaster relief before depending on any extension.
Close and report. Coordinate QI wiring for the replacement closing. File IRS Form 8824 for the year the exchange began and follow California reporting rules if you moved California gain out of state. Review: IRS Form 8824 instructions and California reporting like-kind exchanges.
Track basis and plan ahead. Keep records of your carryover basis, boot, and deferred gain. If you sell later without another 1031, prior deferral and depreciation recapture will come due.
Frequent pitfalls and how to avoid them
- Constructive receipt of funds. Taking possession or control of proceeds can kill the exchange. Mitigation: use an independent QI with strong controls. See the Qualified intermediary overview.
- Weak QI safeguards. Underinsured or careless QIs create risk. Mitigation: perform due diligence on bonding, E&O insurance, and trust accounting before you engage.
- Missed state reporting. California’s FTB 3840 obligations can be easy to overlook. Mitigation: involve a California CPA and follow state reporting guidance.
- Related-party or entity shifts. “Drop-and-swap” strategies draw scrutiny. Mitigation: document intent and consult counsel. Background: California 1031 exchange scrutiny.
- Local use constraints. RSO coverage and Los Angeles Home-Sharing rules limit rent and short-term use. Mitigation: verify parcel status with the LA Housing Department and the Home-Sharing program.
When a reverse or improvement exchange fits
If you need to secure a Palisades property before you sell, a reverse exchange can work by temporarily “parking” title with an accommodation entity. If you plan to build or renovate as part of the exchange, an improvement exchange may apply. These structures are complex, cost more, and require tight coordination with your QI, lender, and escrow. Learn the basics here: exchange accommodation and reverse structures.
Plan your next move
You deserve a clear plan that aligns tax deferral with your long-term goals, property use, and Palisades market realities. If you are considering a sale or purchase that may involve a 1031 exchange, let’s talk through strategy, timelines, and local constraints so you can move with confidence. Reach out to Sarah Griffin for a thoughtful, concierge approach and introductions to vetted QIs and local professionals.
FAQs
Can I use a 1031 for my primary residence in Pacific Palisades?
- Generally no. 1031 applies to property held for investment or business use. Mixed-use properties can be complex, so consult your tax advisor.
What are the 45-day and 180-day deadlines in a 1031 exchange?
- You have 45 days to identify replacement properties in writing and 180 days to close, measured from the date you transfer the relinquished property.
If I buy outside California, do I still owe California reporting?
- Yes. When you exchange California property into out-of-state property, California typically requires Form FTB 3840 reporting until the deferred California-source gain is recognized.
How do LA’s RSO and Home-Sharing rules affect my replacement property?
- They can limit rent increases and short-term rental use. Verify whether the property is RSO-covered and whether it qualifies for Home-Sharing before you commit.
Did the January 2025 wildfires change my 1031 timelines?
- If you were an affected taxpayer with deadlines falling within the relief window, the IRS may extend your 45-day or 180-day dates to October 15, 2025. Confirm eligibility with your CPA.
