Thinking about trading a Bay Area rental for a Santa Rosa duplex and keeping more of your gains working for you? You are not alone. Many North Bay investors look to Sonoma County for stable rents and approachable price points, but a 1031 exchange comes with strict rules and timelines. In this guide, you will learn the essentials of a 1031 exchange, how the 45- and 180-day deadlines work, what counts as taxable “boot,” and what to watch in Santa Rosa before you buy. Let’s dive in.
What a 1031 exchange does
A 1031 exchange lets you sell investment or business real property and defer federal capital gains tax and depreciation recapture if you buy another like-kind real property. The key is deferral, not forgiveness. Taxes generally become due when you eventually sell without another qualifying exchange. You can review how like-kind exchanges work in IRS Topic No. 703 and the broader rules in IRS Publication 544.
What qualifies as like-kind
To qualify, both the property you sell and the property you buy must be real property held for investment or for use in a trade or business. This includes rentals, small apartment buildings, commercial space, and investment land. Primary residences generally do not qualify. U.S. property must be exchanged for U.S. property. You will find these fundamentals in IRS Publication 544.
Real property only after 2017
After the Tax Cuts and Jobs Act of 2017, personal property does not qualify for like-kind nonrecognition for most taxpayers. Exchanges are now limited to real property for federal purposes. The IRS summarizes this change in Topic No. 703.
Common exchange types
Delayed exchange
This is the most common approach for small investors. You sell your relinquished property, the proceeds go to a qualified intermediary, and you close on the replacement property within the required timelines. You do not take possession of the sale proceeds at any time.
Reverse or improvement exchanges
In a reverse exchange, you buy the replacement property first while an Exchange Accommodation Titleholder holds title to one property during the process. In an improvement exchange, funds or title are held while you complete improvements before you take ownership. These structures are more complex and often costlier, so plan ahead with your qualified intermediary and CPA.
The 45/180-day timeline
The clock starts the day your sale closes. These deadlines are firm and do not have extensions.
Identify within 45 days
You have 45 calendar days from the sale closing to identify potential replacement properties in writing and deliver that identification to your qualified intermediary or another permitted party. You must follow one of these identification rules:
- 3-property rule: identify up to three properties regardless of value.
- 200% rule: identify more than three properties as long as their total value does not exceed 200% of the relinquished property’s value.
- 95% rule: if you exceed those limits, you must acquire at least 95% of the total value identified.
The IRS covers the identification mechanics in Topic No. 703.
Close within 180 days
You must close on your replacement property within 180 calendar days after the sale of your relinquished property, or by the due date of your tax return for that year if earlier. In practice, the 180-day period is binding for most investors. You will report the exchange on IRS Form 8824.
Your qualified intermediary matters
A qualified intermediary (QI) must be in place before your sale closes. The QI prepares exchange documents, holds funds, and coordinates closings so you never receive or control the proceeds. If you or a related party touches the funds, it can trigger constructive receipt and disqualify the exchange. Choose a QI with experience, insurance, and clear procedures. The Federation of Exchange Accommodators sets industry standards and is a helpful resource when you start your search.
Taxes, boot, and mortgages
What gets deferred vs. taxed
When you meet all 1031 rules, your realized gain and depreciation recapture are generally deferred. If you receive any non-like-kind property or cash, this is “boot” and is taxable to the extent of the gain realized. The IRS explains the tax effects and calculations in Publication 544.
Cash and debt boot
You can create boot in two common ways:
- Cash boot: you take any cash out at closing or after the exchange.
- Mortgage boot: the mortgage on your replacement property is lower than the mortgage you paid off, and you do not add cash to offset the difference.
To fully defer, match or increase your total debt on the replacement purchase, or add enough cash to make up any difference.
Depreciation recapture
Depreciation you claimed on the relinquished property is usually deferred in a proper exchange, but it does not disappear. If you later sell in a taxable transaction, depreciation recapture can become taxable, including at the 25% rate for unrecaptured Section 1250 gain for certain real property. See the guidance in Publication 544 for more detail.
Coordinate with your lender early
Tell your lender about the exchange at the start. Lenders may have payoff letter requirements, seasoning rules, or timing steps that affect your 45- and 180-day windows. Early alignment avoids last-minute delays that can jeopardize your exchange.
California and Sonoma considerations
California generally conforms to federal treatment for like-kind exchanges of real property, and California taxes capital gains as ordinary income. State rules can have nuances, and property tax reassessment may apply when title changes. For state tax questions, start with the California Franchise Tax Board and speak with a California CPA. For local reassessment or transfer tax questions in Sonoma County, contact the county assessor or a local property tax attorney.
Santa Rosa and Sonoma County cities also have local rules for landlords and short-term rentals. Check city and county requirements on tenant protections, occupancy limits, permits, and short-term rental regulations before you identify a property.
Santa Rosa investor scenarios to consider
Bay Area single-family into a Santa Rosa multi-unit
Many investors exchange a single-family rental from a coastal Bay Area city into a Santa Rosa duplex, triplex, or small apartment building. You may find a lower acquisition price per unit and the potential for stronger cash flow. Balance that with property management costs, local tenant protections, and any needed upgrades to meet local codes.
Consolidate vs. diversify
You can use the 3-property identification rule to buy multiple replacement properties or consolidate into one newer asset. Consider the trade-off between having several doors across different neighborhoods and the simplicity of one property. Factor in vacancy cycles, maintenance reserves, and the time you want to spend managing.
Short-term rental interest
Tourism influences parts of Sonoma County, but short-term rental rules vary by city and can change. Confirm what is allowed for your target property, including permits, occupancy limits, and tax requirements, before you identify or close.
Step-by-step 1031 checklist
- Before listing your relinquished property:
- Interview and retain a qualified intermediary.
- Talk to your CPA about federal and California impacts and to model outcomes.
- Confirm mortgage payoff timing and any lender requirements.
- At sale closing:
- Route sale proceeds directly to the QI. Do not receive funds.
- Record the exact transfer date. Your 45- and 180-day clocks start now.
- Within 45 days (identification period):
- Deliver written identification of replacement property to your QI.
- Follow the 3-property, 200%, or 95% rule precisely.
- Within 180 days (exchange period):
- Close on one or more identified properties by day 180 or the earlier return due date.
- Ensure your replacement debt meets or exceeds prior debt, or add cash to avoid mortgage boot.
- After the exchange:
- File Form 8824 with your federal tax return.
- Keep complete records: exchange agreement, identification notices, QI statements, settlement statements, and title documents.
Avoid these costly pitfalls
- Missing the 45-day identification or 180-day closing deadlines. There are no extensions.
- Starting without a QI in place before closing the sale.
- Touching or controlling sale proceeds, which risks constructive receipt and disqualification.
- Underestimating costs like QI fees, legal and title fees, or carrying costs in reverse or improvement exchanges.
- Overlooking California income tax nuances or local property tax reassessment.
- Entering related-party transactions without understanding the IRS holding period rules and risks. Always consult your CPA first.
Work with the right team
A smooth exchange comes from planning. Your core team should include:
- Qualified intermediary: administers the exchange, holds funds, and coordinates documents.
- CPA or tax advisor: models your federal and California outcomes, prepares Form 8824, and advises on depreciation and boot.
- Real estate attorney: helps with complex structures like reverse or improvement exchanges.
- Local real estate agent and property manager: sources properties, vets rents and expenses, and explains Santa Rosa regulations and operating costs.
- County assessor or property tax counsel: advises on reassessment and transfer tax.
If you are exploring a 1031 into or out of Santa Rosa, we can help you evaluate replacement options, run property-level assumptions, and coordinate timing with your QI and CPA. To discuss your plan and the local landscape, reach out to Pat Kelly Real Estate. Request a Free Home Valuation or Market Consultation.
FAQs
Can I exchange a Bay Area rental into a Santa Rosa rental?
- Yes. If both are U.S. real property held for investment and you meet the 1031 rules and deadlines, you can exchange between Bay Area and Santa Rosa properties. See IRS Topic No. 703 for like-kind basics.
How many replacement properties can I identify in 45 days?
- You can use the 3-property rule, the 200% rule, or the 95% rule. Identification must be in writing and delivered within 45 days per IRS Topic No. 703.
What happens if I receive cash during the exchange?
- Cash received is cash boot and is taxable to the extent of your realized gain. Review examples and tax treatment in IRS Publication 544.
Do I need to match my prior mortgage on the replacement property?
- Not exactly, but if your new debt is lower, the shortfall can be mortgage boot unless you add cash to offset it. Plan this with your lender and CPA.
Does California follow federal 1031 rules for real property?
- Generally yes for real property, but state specifics and property tax reassessment can vary. Start with the California Franchise Tax Board and consult a California CPA and the Sonoma County Assessor before you proceed.
