1031 Exchange in Texas

Texas's tax picture on a sale

Texas imposes no state personal income tax, so the capital gain on a Texas real estate sale is not taxed at the state level (approximate — verify current rules with your CPA). That is a genuine advantage, but it does not make a sale tax-free. What remains is the federal exposure:

• ›Federal long-term capital-gains tax — generally up to 20% on the appreciation portion.
• ›Federal depreciation recapture — often taxed at up to 25%, a higher rate than the capital-gains portion itself.
• ›Net investment income tax (NIIT) — an additional 3.8% for higher earners.

Even without a state bill, the federal portion of a fully taxable sale on a long-held, appreciated property can be substantial — which is why a 1031 exchange still matters in Texas.

No state income tax — but federal still applies

The absence of state income tax is real, but the federal layers can still take a large bite. Depreciation recapture in particular surprises owners: years of depreciation deductions taken against rental income are recaptured on sale, often at a 25% federal rate, even though they reduced taxable income in prior years.

• ›A 1031 exchange defers both the capital-gains and the recapture components at the federal level.
• ›So even in a no-income-tax state like Texas, an exchange can preserve significant capital that would otherwise go to the IRS.
• ›The Texas advantage is best thought of as removing one of several layers, not as eliminating the case for deferral.

The relocation and retirement angle

Texas is a common landing spot for investors leaving high-tax states such as California, New York, and New Jersey. A key planning point that trips people up:

• ›Moving to Texas does not retroactively erase tax on property you owned in your former state. If you exchange out of California or New York property, the origin state's rules — including clawback (California's Form 3840) or nonresident withholding — can still follow that gain.
• ›Once you own Texas property, future sales avoid state income tax. The benefit is forward-looking, not retroactive.
• ›Sequencing matters — when you move, when you sell, and when you exchange all interact. Plan the move and any exchanges with a CPA who understands both states.

A worked illustrative example

Suppose a Texas investor sells a rental for $1,000,000 with a basis of $350,000, a $650,000 gain, of which $200,000 is attributable to prior depreciation (a simplified illustration; your numbers will differ).

• ›There is no Texas state income tax on the gain.
• ›Depreciation recapture at up to 25% on the $200,000 could be roughly $50,000.
• ›Federal capital-gains tax plus NIIT on the remaining ~$450,000 could plausibly add $90,000–$110,000.
• ›The federal-only bill might therefore fall in the $140,000–$160,000 range — meaningful even without state tax.
• ›A valid 1031 exchange defers all of it, keeping the capital invested in the replacement property.

Illustrative only — confirm actual figures with your CPA.

How a 1031 (and DSTs) help Texas owners

A 1031 exchange lets a Texas owner defer federal tax by reinvesting proceeds into like-kind real estate within the 45-day and 180-day windows. DSTs are popular among Texas owners and newcomers because they:

• ›Convert a single management-heavy property into fractional interests in institutional, professionally managed real estate.
• ›Provide diversification across markets and property types.
• ›Pair federal deferral with a hands-off, passive ownership structure.

For retirees settling in Texas who want income without landlord duties, that combination is the main draw. (DSTs carry their own risks and no returns are guaranteed.)

Local market notes

Texas's fast-growing metros — Dallas–Fort Worth, Austin, Houston, and San Antonio — have produced strong appreciation, and the no-income-tax environment continues to attract investors and retirees from higher-tax states. Many newcomers arrive carrying a property in a high-tax origin state that they intend to sell or exchange. For them, the planning question is rarely "is there Texas tax?" (there isn't) but rather "what does my former state still claim, and how do I defer the federal layer?"

Residency caveat: deferral is not erasure

A 1031 exchange postpones federal tax; it does not erase it, and Texas's lack of state income tax does not change the federal picture.

• ›You remain taxable where you reside for any state that does levy income tax.
• ›Relocating to Texas does not undo tax tied to property you held in a former high-tax state — origin-state clawback or withholding can still apply.
• ›The deferred federal gain remains taxable when eventually recognized.

Next steps

• ›Model the federal exposure — including recapture — before listing.
• ›If you recently moved, map what your former state still claims on prior-state property.
• ›Engage a qualified intermediary before closing.
• ›Plan the sequence of your move, sale, and any exchange with a CPA who knows both states.

This is educational only, not tax or legal advice. Rules are approximate and change — verify the current federal rules and your facts with a qualified CPA.