1031 Exchange Guide for Industrial Property Owners in California

For industrial property owners in California, a 1031 exchange represents one of the most powerful wealth-building tools available. By deferring capital gains taxes when selling investment property, you can preserve more of your equity to reinvest in larger or better-performing assets.

However, the 1031 exchange process is governed by strict IRS rules and tight timelines. A single misstep can disqualify your exchange and trigger a substantial tax liability. This guide covers everything industrial property owners need to know to execute a successful exchange.

What is a 1031 Exchange?

A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows investors to defer paying capital gains taxes when they sell an investment property and reinvest the proceeds into a "like-kind" replacement property.

The key word is defer—you're not eliminating the tax obligation, but postponing it until you eventually sell without exchanging. Many investors continue exchanging throughout their lifetime, potentially passing properties to heirs who receive a stepped-up basis.

For California industrial property owners, the combined tax burden on a property sale can exceed 50% when you factor in federal capital gains, California state tax, depreciation recapture, and the net investment income tax. A 1031 exchange defers all of these taxes.

Critical Timelines: The 45-Day and 180-Day Rules

The 1031 exchange is governed by two strict, non-negotiable deadlines. Missing either deadline will disqualify your exchange entirely.

The 45-Day Identification Period

Within 45 calendar days of closing on your sale, you must identify potential replacement properties in writing to your Qualified Intermediary (QI). This deadline is absolute—there are no extensions, even for weekends or holidays.

You can identify properties using one of three rules:

• Three-Property Rule: Identify up to three properties of any value
• 200% Rule: Identify any number of properties, as long as their combined value doesn't exceed 200% of the relinquished property's sale price
• 95% Rule: Identify any number of properties if you acquire at least 95% of their combined value (rarely used)

Most exchangers use the Three-Property Rule for its simplicity and flexibility.

The 180-Day Exchange Period

You must close on your replacement property within 180 calendar days of selling your relinquished property. This deadline runs concurrently with the 45-day identification period—it's not 45 days plus 180 days.

Requirements for a Valid Exchange

To successfully defer taxes through a 1031 exchange, you must meet several requirements:

Like-Kind Property

Both the relinquished and replacement properties must be "like-kind," which for real estate is interpreted broadly. An industrial warehouse can be exchanged for an office building, retail center, apartment complex, or raw land—any real property held for investment or business use qualifies.

However, you cannot exchange into property held primarily for personal use (like a vacation home you'll use frequently) or property held for sale (like fix-and-flip inventory).

Equal or Greater Value

To defer 100% of your capital gains, your replacement property must be of equal or greater value than the property you sold. You must also reinvest all of the net proceeds and replace any debt that was paid off.

If you receive cash or reduce your debt without replacing it, that "boot" is taxable in the year of the exchange.

Qualified Intermediary Requirement

You cannot touch the sale proceeds at any point during the exchange. A Qualified Intermediary (QI) must hold the funds between the sale of your relinquished property and the purchase of your replacement property.

The QI must be established before you close on your sale. Choose a reputable QI with proper insurance and segregated accounts—your exchange funds should never be commingled with the QI's operating funds.

Replacement Property Strategies for Industrial Owners

Finding the right replacement property within the 45-day identification window requires advance planning. Here are strategies industrial property owners should consider:

Trading Up in Size or Quality

Many exchangers use the 1031 to move from a smaller property to a larger one, or from a B-class asset to an A-class asset. For example, exchanging a 20,000 SF multi-tenant industrial building into a 50,000 SF distribution facility.

Geographic Diversification

If you're heavily concentrated in one submarket, an exchange provides an opportunity to diversify into other markets. You might exchange a Contra Costa County property into assets in Sacramento, Central Valley, or even out-of-state markets.

Asset Class Diversification

While this guide focuses on industrial, remember that 1031 exchanges allow you to move between property types. Some industrial owners exchange into NNN retail, multifamily, or Delaware Statutory Trusts (DSTs) for more passive income.

Delaware Statutory Trusts (DSTs)

DSTs are fractional ownership interests in institutional-quality properties. They're particularly useful when you can't find suitable replacement property within the 45-day window, or when you want to transition to passive ownership. DSTs can be identified alongside traditional properties as a backup.

Common 1031 Exchange Mistakes to Avoid

After facilitating dozens of 1031 exchanges, I've seen these mistakes derail otherwise well-planned transactions:

1. Waiting too long to start: Begin identifying potential replacement properties before you even list your property for sale. The 45-day window goes quickly.
2. Not setting up the QI in time: The QI must be in place before your sale closes. Last-minute scrambles create risk.
3. Taking constructive receipt: If sale proceeds are deposited into your account, even briefly, your exchange is disqualified.
4. Identifying too few properties: Use all three slots under the Three-Property Rule. Deals fall through, and you need backups.
5. Underestimating replacement value: Ensure your replacement property value covers both your equity and debt to avoid taxable boot.
6. Forgetting about California clawback: California tracks 1031 exchanges. If you exchange into an out-of-state property and later sell, California may claim its share of the original deferred gain.

Start Planning Your Exchange Early

The most successful 1031 exchanges start with planning long before the property is even listed for sale. By identifying potential replacement properties early and building relationships with sellers, you'll be positioned to move quickly when your sale closes.

I work with industrial property owners throughout the East Bay to plan and execute 1031 exchanges. From pricing your relinquished property to identifying suitable replacements within our market, I can guide you through every step of the process.

Alex Peck

Principal at Lee & Associates East Bay, specializing in multi-tenant industrial properties throughout the East Bay and Solano County markets.

apeck@lee-associates.com · (925) 239-1414