California Proposed Regulation Expands Taxation of Deferred Real Estate Gains for Nonresidents
California CCR §17951-7 Proposed Amendments on Sourcing of Real Property Gains
The California Franchise Tax Board has released proposed amendments to California Code of Regulations Title 18 section 17951-7 addressing how gains and losses from real property are sourced for nonresidents. The proposal is scheduled for discussion at an Interested Parties Meeting on January 27 2026.
Although described in part as clarifications and technical revisions, the proposed amendments are significant and substantive. They materially reshape how California sources both deferred and recognized gain involving California real property, including transactions arising from like kind exchanges under Internal Revenue Code section 1031 and involuntary conversions under Internal Revenue Code section 1033.
Statutory Foundation
California Revenue and Taxation Code section 17951 provides that income derived from real or tangible property located in California is California source income taxable to nonresidents. This statute is the foundational authority for the sourcing rules applied in the regulation. At the federal level Internal Revenue Code section 1031 governs nonrecognition of gain or loss for qualifying real property exchanges and Internal Revenue Code section 1033 governs nonrecognition of gain on qualifying involuntary conversions.
Key Proposed Regulatory Changes
The proposed amendments retitle the regulation from deferred gains and losses from exchanges of real or tangible property in this state to gains or losses involving real property from sources within this state. This change reflects a shift away from centering the regulation on deferral mechanics and toward sourcing gain or loss at the time it is recognized.
The amendments also remove references to tangible personal property and limit the regulation to real property only. This aligns the regulation with the post TCJA federal limitation of section 1031 to real property and with California conformity updates.
Most significantly the amended regulation sources California income at the time a gain or loss is recognized rather than at the time of the original exchange or conversion. Deferred gain attributable to California real property remains California source income when later recognized even if the taxpayer is no longer a California resident or the replacement property is located outside California.
Key Tax Impacts for Taxpayers
- Deferred gain tied to California real property retains California source character upon later recognition
- Nonresidents can face California tax exposure long after a section 1031 exchange or section 1033 deferral
- Recognition events such as later sales become the focal point for California sourcing and enforcement
- Residency planning alone does not eliminate California tax exposure tied to prior California real estate
Why These Changes Matter
While the proposal does not cite specific administrative rulings, the approach is consistent with established principles allowing California to tax nonresidents on income derived from California real property. By emphasizing recognition events, the amendments strengthen California’s position that deferred gain retains its California source character when later recognized.
Nonresidents and real estate investors with current or historic section 1031 or section 1033 transactions involving California real property should reassess exit strategies and the timing of recognition events in light of the proposal. If finalized, the amended regulation will become a primary administrative authority for sourcing gains and losses involving California real property.
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