1031 Exchange in Arizona: Rules, Taxes, and What the State Does Not Do

The rules: federal statute, Arizona conformity

Arizona's income tax begins with federal adjusted gross income (A.R.S. §43-1001) and then applies a list of additions and subtractions. Nothing on the additions list touches gain deferred under IRC §1031, so a like-kind exchange that works federally works for Arizona by default, in the same year and the same amount, with no state election and no Arizona counterpart to Form 8824. The Department of Revenue does not review exchanges separately; it accepts the federal return's treatment.

The operating rules are therefore the ones every exchanger follows: a qualified intermediary under contract before the relinquished property closes, written identification within 45 days, acquisition of the replacement within 180 days or the due date of your return, and replacement value and debt at least equal to what you gave up if you want to avoid boot. Like-kind is national: a Scottsdale fourplex can become a Nashville warehouse, a Denver apartment building can become a Mesa industrial condo, and either can become a fractional interest in a Delaware statutory trust that owns property in several states at once.

The stakes: 2.5% flat, minus a quarter of the gain

Arizona moved to a single 2.5% individual rate for tax years beginning in 2023, the lowest flat rate among the states that tax income at all, and the rate carries no sunset. Capital gain is taxed as ordinary income at that rate, but with an unusual sweetener: under A.R.S. §43-1022, 25% of the net long-term capital gain included in federal adjusted gross income from assets acquired after December 31, 2011 is subtracted before the rate applies. Unrecaptured §1250 gain is long-term capital gain for this purpose, so on an investment property bought in 2012 or later the entire gain, recapture included, qualifies. The effective Arizona rate on that gain is 1.875%. On property acquired before 2012 the full 2.5% applies.

Put against the federal bill, the state piece is nearly a rounding error. On an $825,000 gain from a post-2011 asset, Arizona's share is about $15,500; the federal share, with 25% recapture, 20% long-term gain, and the 3.8% net investment income tax, is roughly $213,000. Our state-by-state table ranks Arizona among the lowest combined rates in the country. An Arizona exchange is a federal decision; the state deferral is welcome but will not change the answer.

Closing: no withholding, no affidavit, no transfer tax

Investors arriving from California, Colorado, Georgia, or New York expect a state form at closing that addresses tax on the sale. Arizona has none. The state imposes no withholding on nonresident sellers of real estate, so there is no exemption certificate to sign, no like-kind affidavit to negotiate with the title company, and no risk that part of the exchange proceeds is diverted to the Department of Revenue while the intermediary waits. A nonresident who sells for cash owes Arizona tax on the gain and pays it with a Form 140NR; the state trusts the return rather than the closing. Federal FIRPTA withholding on foreign sellers is unaffected.

Arizona also has no real estate transfer tax, and cannot adopt one. Proposition 100, approved by voters in 2008, added Article IX, §24 to the state constitution, which prohibits the state and every political subdivision from imposing any new tax, fee, or stamp requirement on the sale or transfer of real property. Both legs of an exchange therefore close without a transfer levy, which is a meaningful saving against states that charge on each conveyance. The one piece of paper the county recorder does require is the Affidavit of Property Value (Form 82162), a disclosure the assessor uses for valuation, not a tax. Exchanges are not an exemption category on the affidavit; the sale is reported like any other.

Leaving Arizona: no clawback

Four states take the position that gain deferred on property inside their borders remains theirs to tax when the replacement property is eventually sold, wherever that property sits and wherever the taxpayer then lives; California administers this with an annual Form 3840, and Oregon, Montana, and Massachusetts have their own versions. Arizona is not one of them. There is no Arizona statute reaching deferred gain after the taxpayer leaves, no annual information return, and no assessment practice that follows an exchange out of state.

The planning point is the same one that applies in Colorado and Texas: an Arizona owner who exchanges into property in a no-income-tax state and later becomes a resident there has converted an Arizona deferral into permanent Arizona avoidance. The difference in Arizona is how little is being avoided. At 1.875% to 2.5%, the state tax is rarely the reason to exchange out, and investors frequently run the opposite direction, exchanging into Arizona from California precisely because the California clawback, at up to 13.3%, is the number that matters.

Property tax: Prop 117 and the ratio step-down

Arizona assesses two values on every parcel. The full cash value tracks the market. The limited property value is what taxes are actually levied on, and since tax year 2015, under the Proposition 117 amendment, it can rise no more than 5% per year and can never exceed full cash value. The question an exchanger cares about is whether buying a property resets its limited value to the purchase price, as a sale does in California. It does not. Under A.R.S. §42-13302 the limited value is recalculated only when property was omitted from the roll, changes use, is split or combined, or has new construction or demolition; a change of ownership is not on the list. The buyer of a Tempe apartment building inherits the seller's limited value and the 5% cap on its growth, which in a market that appreciated 40% between 2020 and 2022 can mean a tax base well below the price paid.

Classification is where the money moves. Taxes equal limited value times an assessment ratio times the local rate, and the ratio depends on legal class. Residential rental property (Class 4) and owner-occupied homes (Class 3) are assessed at 10%. Commercial and industrial property (Class 1) has been assessed at a much higher ratio that the legislature is stepping down: 16% for 2025, 15.5% for 2026, and 15% for 2027 and after under A.R.S. §42-15001. An exchange from a Phoenix apartment complex into a Phoenix retail center of the same value therefore raises the property-tax bill by roughly half, before any difference in local rates; the reverse exchange lowers it. Bills to accelerate the Class 1 reduction further have been introduced in recent sessions and had not passed as of this writing.

The rental tax that disappeared in 2025

For decades Arizona was one of a handful of states where cities taxed residential rent. Most cities and towns, Phoenix and Scottsdale among them, levied a transaction privilege tax of 1.5% to 3% on monthly residential rents, which landlords either absorbed or passed through on the lease. Legislation adopted in 2023 (Laws 2023, Ch. 204) ended it: from January 1, 2025, no city or town may impose TPT on the business of renting real property for residential purposes. A multifamily asset in Scottsdale that was remitting 1.75% of gross rents to the city in 2024 remits nothing in 2026, a direct addition to net operating income that underwriters in other states may not expect to find.

Two carve-outs matter for exchangers. Commercial leases remain taxable: there is no state-level TPT on commercial rent, but several counties and most cities tax it under business code 213 at rates that vary by jurisdiction, so an office or retail acquisition still carries a rental tax line. And short-term rentals of under thirty days were never residential rentals for this purpose; they are taxed as transient lodging, with combined state, county, and city rates that exceed 14% in Scottsdale and are collected by the platforms or the operator. An exchange from a long-term rental into a resort STR changes the tax posture of the income entirely.

Arizona-specific like-kind questions: water, trust land, STRs

Groundwater rights. Inside the state's active management areas, the 1980 Groundwater Code converted historic pumping into grandfathered rights administered by the Department of Water Resources. Irrigation rights and Type 1 non-irrigation rights are tied to the land and move with it; Type 2 non-irrigation rights are not tied to any parcel and can be conveyed on their own, and an active market in them exists. Whether a separately conveyed Type 2 right is real property for §1031 purposes turns on its characterization under Arizona law, since Treas. Reg. §1.1031(a)-3 defers to state law on interests it does not list. Practitioners have exchanged Arizona water rights, but the authority is thinner than for Colorado's adjudicated rights, and a buyer or seller treating a Type 2 right as like-kind should have a written opinion. Central Arizona Project allocations, which are contractual entitlements rather than property, are a harder case.

State trust land. About thirteen percent of Arizona is held in trust for the public schools and leased, not sold, by the State Land Department; commercial leases of up to 99 years are awarded at public auction. A leasehold with at least thirty years remaining is like-kind to a fee interest under the regulations, so a long state-trust ground lease can be relinquished or acquired in an exchange, and much of the development around Phoenix's semiconductor corridor sits on exactly this kind of ground. The lease terms, the auction process, and any reversion clauses belong in the diligence file.

Short-term rentals. Scottsdale, Sedona, and the Flagstaff area are heavy STR markets. Arizona law since 2016 bars cities from banning short-term rentals, and since 2022 lets them require licenses, local emergency contacts, and insurance; legislation in the 2026 session proposed occupancy limits and license suspension after repeated violations, and further bills are expected. Separately, the federal question is whether the property is held for investment at all: a vacation unit the owner uses personally must fit the Rev. Proc. 2008-16 safe harbor on both sides of the exchange, with at least fourteen days of fair-value rental and personal use capped at the greater of fourteen days or ten percent of rental days, in each of two years.

The Arizona market: what exchangers trade

Metro Phoenix is one of the largest exchange markets in the country, and its character has shifted. The multifamily supply wave peaked in 2024 and 2025, when the metro delivered nearly thirty thousand units in a single year; rents fell, concessions spread, and occupancy slipped into the low nineties before absorption began to outpace deliveries. By mid-2026 construction starts had thinned and rents had posted their first sequential gain in two years. For exchangers that has meant stabilized 2010s product trading below replacement cost from sellers facing loan maturities, which is the buying opportunity the last cycle did not offer.

Industrial and advanced manufacturing is the other side of the Phoenix story. The semiconductor campus in north Phoenix has grown through successive announcements into a multi-hundred-billion-dollar plan with additional fabs under discussion, and the supplier parks, logistics hubs, and housing around it have become a distinct exchange destination for investors leaving coastal multifamily. Tucson's industrial market has loosened as new product delivered. The resort and second-home markets, Scottsdale, Sedona, and the high country around Flagstaff and Prescott, run on the STR rules above and on the investment-intent question that sits beneath them. The agricultural and land markets of Pinal and Maricopa counties involve the water questions above and a steady flow of farmland converting to housing, where the seller's exchange and the developer's purchase are often negotiated together.

Exchanging into Arizona from out of state

If you acquire Arizona replacement property and do not become a resident, you will file a Form 140NR each year to report the Arizona-source rental income and pay 2.5% on the net. When you eventually sell, the gain on the Arizona property is Arizona-source income whether or not you ever lived here, reportable on the same nonresident return, and the 25% long-term-gain subtraction is available on the Arizona return as it would be for a resident. There is no closing-table collection; the state will expect the return.

Arrivals from California should keep the Form 3840 obligation on their calendar. The clawback follows the deferred California gain into the Arizona property for as long as it is embedded there, and a missed annual filing can let the Franchise Tax Board assess the deferred amount. Arrivals from no-income-tax states acquire an Arizona filing requirement they did not previously have, which is modest but real.

Finding a qualified intermediary in Arizona

Arizona does not license or regulate exchange facilitators. The states that do, among them California, Colorado, Nevada, Oregon, Washington, Idaho, Maine, and Virginia, impose bonding, insurance, or segregated-account rules; an Arizona exchanger has none of that by statute and relies on the exchange agreement and the intermediary's own practices. That makes the checklist in our QI guide the operative one: a fidelity bond and errors-and-omissions coverage, qualified escrow or trust accounts, segregation under your taxpayer identification number, dual-signature release of funds, and a parent with a balance sheet. The Phoenix local pack for this search shows national intermediaries with Arizona offices alongside title-company affiliates and a few boutiques; price them against our fee comparison, and expect a standard delayed exchange to cost roughly what it costs anywhere else.

An Arizona worked example

Same property as the calculator's standard example, relocated to Tempe; assumptions per our methodology. The exchange keeps $228,820 working. Had the building been acquired before 2012 the Arizona line would be $20,625; either way the federal deferral is 93% of the benefit.