1031 Exchange in Arizona: 2.5% Flat Tax, LPV Cap and No Transfer Tax

Arizona starts with federal AGI, so the §1031 deferral is automatic on Form 140

A.R.S. §43-1001 defines a resident's Arizona gross income as federal adjusted gross income computed under the Internal Revenue Code. Gain that §1031 keeps out of federal AGI is therefore never part of the Arizona return, with no addition, subtraction or election to make.

Arizona has no post-exchange information return and no rule that tracks gain deferred into property outside the state. If the replacement property is later sold in a taxable transaction, Arizona taxes the gain at that point only if the seller is then an Arizona resident or the property is in Arizona.

The Senate's February 2026 fact sheet for S.B. 1633 restates the structure: the tax base begins with Arizona gross income, 'which is equivalent to the taxpayer's federal adjusted gross income', followed by statutory additions and subtractions. Exchange sellers can read the federal eligibility rules knowing that Arizona simply adopts the federal result.

The 2.5 percent flat rate and the 25 percent long-term gain subtraction (post-2011 assets only)

Arizona's individual income tax is a flat 2.5 percent: the Department of Revenue's Form 140 instructions compute the tax by multiplying taxable income by 2.5 percent. On a taxable sale, that is the headline rate on the gain.

A.R.S. §43-1022(22) then subtracts 25 percent of any net long-term capital gain included in federal AGI, but only for gain 'derived from an investment in an asset acquired after December 31, 2011'. A rental bought in 2015 and sold at a long-term gain is taxed on 75 percent of it, an effective 1.875 percent; a rental bought in 2005 gets no subtraction and pays the full 2.5 percent.

That acquisition-date test changes the exchange arithmetic for long-held Arizona property. An owner since before 2012 faces the full rate on a taxable sale, while an exchange defers all of it, and the replacement property, acquired after 2011, would qualify for the subtraction if it is ever sold taxably. Confirm the holding-period and acquisition-date facts for your property with your CPA.

No withholding at closing: escrow agents file an information return instead

Arizona has no nonresident real estate withholding statute. What A.R.S. §43-312 requires is that a licensed escrow agent file an information return of Arizona real property sales, in the same form and format as the federal Form 1099-S filing, by March 31 for sales closed in the prior calendar year.

The same section directs the Department of Revenue to estimate each year the capital gains tax paid by nonresidents on Arizona real estate transactions. Nonresidents therefore owe Arizona tax on gain from Arizona property, but nothing is taken at the closing table and no exemption certificate is needed for an exchange.

For an exchange seller this removes a step that exists in California, Alabama and a number of other states: the intermediary receives the full net proceeds with no state withholding to claim back.

Arizona's constitution bans transfer taxes; the Affidavit of Property Value is the only conveyance paperwork

Article IX, §24 of the Arizona Constitution prohibits the state, counties, cities, towns and districts from imposing 'any new tax, fee, stamp requirement or other assessment' on selling, purchasing or otherwise conveying an interest in real property, grandfathering only what existed on December 31, 2007. Arizona has no documentary or deed transfer tax on either side of an exchange.

What the recorder does require is an Affidavit of Property Value under A.R.S. §11-1133, signed by seller and buyer or their agents and appended to the deed. It declares the total consideration, the down payment and the type of financing, and one of the listed financing types is 'an exchange or trade of property', so an exchange is disclosed on the public record even though no tax follows.

The recorder will refuse the deed without a complete affidavit unless the instrument carries an exemption code under §11-1134. Title and escrow companies prepare the form as a matter of course; the exchanger's job is to make sure the consideration figure matches the exchange documents.

Limited Property Value does not reset on sale: Prop 117, Rule B and the 15.5 percent commercial ratio

Arizona property tax is levied on Limited Property Value (LPV), which under Proposition 117 and A.R.S. §42-13301 can rise no more than 5 percent a year (Rule A), never above full cash value. A fresh LPV under Rule B (A.R.S. §42-13302) is set only for property omitted from the roll, a change in physical use, construction or demolition worth 15 percent or more of full cash value, splits and consolidations, and loss of a senior valuation protection or a statutory valuation.

A sale is not on that list. The buyer of an Arizona rental inherits the seller's LPV and its 5 percent cap, so exchanging does not hand the buyer a reassessment, and buying Arizona replacement property does not saddle the exchanger with one. This is the opposite of California's Proposition 13 change-in-ownership rule.

The assessment ratio depends on class. Class one, the class that includes commercial property, is 15.5 percent of value for tax year 2026 and 15 percent from 2027 under A.R.S. §42-15001; class three (owner-occupied homes) and class four (residential rentals) are 10 percent under §§42-15003 and 42-15004. Exchanging out of a commercial building and into an Arizona apartment DST would move the property-tax base from the 15.5 percent ratio to the 10 percent one.

Residential rental TPT ended in 2025; community property decides who signs

Since January 1, 2025, Arizona cities and towns may no longer levy transaction privilege tax on the business of renting residential real property (S.B. 1131, 56th Legislature), so an Arizona landlord who sells no longer has a municipal rental-tax license to close out; the change covers residential rentals only.

Arizona is a community property state: A.R.S. §25-211 makes property acquired by either spouse during marriage community property, other than gifts, inheritances and property acquired after service of a petition for dissolution. Both spouses generally sign the relinquished-property deed and the exchange agreement, and the replacement property is usually taken in the same community form, a point to raise with the intermediary at engagement.