The short answer
A 1031 exchange of Texas investment property defers federal capital gains and recapture tax; Texas has no income tax to defer, its constitution now bars a capital gains tax, and there is no closing withholding, no transfer tax and no deferred-gain reporting. The state's costs are the franchise tax an LLC or limited partnership pays once its total revenue passes $2.65 million and the county appraisal district's annual market-value appraisal. A Texas seller who exchanges into a DST typically picks up nonresident returns wherever the DST's buildings are located.
Texas at a glance
| State tax on the gain | None; Art. VIII §24-a bars an income tax and §24-b (Nov. 2025) bars a capital gains tax |
|---|---|
| Franchise tax | 0.75% of margin; no tax due at or below $2,650,000 total revenue for 2026 and 2027 reports |
| Passive entity carve-out | Partnerships and non-business trusts only, 90% passive income; rent does not count |
| Real estate transfer tax | None; Art. VIII §29 forbids a transfer tax on conveyances of fee simple title |
| Withholding at closing | None; Texas has no real estate withholding for resident or nonresident sellers |
| Deferred-gain claw-back | None; no Texas counterpart to California's Form FTB 3840 |
| Non-homestead appraisal cap | 20% cap for non-homestead real property up to $5M (2024, indexed); expires Dec. 31, 2026 |
| Agricultural rollback | Three years of back taxes when open-space agricultural land changes use (Tax Code §23.55) |
The Texas Constitution rules out an income tax and, since November 2025, a capital gains tax
Article VIII, Section 24-a of the Texas Constitution, added November 5, 2019, forbids the Legislature from taxing the net incomes of individuals, including an individual's share of partnership income. Section 24-b, added November 4, 2025, goes further and bars any tax on the realized or unrealized capital gains of an individual, family, estate or trust, including a tax payable on the sale or transfer of a capital asset.
For the seller of a Houston industrial building or an Austin rental portfolio, that leaves federal tax as the only income tax on the sale, and a 1031 exchange defers it. Texas has no real estate withholding at closing and nothing resembling California's Form FTB 3840, the annual report California demands when California property leaves for an out-of-state replacement, so gain deferred out of Texas is never traced back.
Franchise tax: which rental entities owe it, the $2.65 million threshold and the passive-entity carve-out
Texas taxes entities, not people. Under Tax Code §171.0002 a limited liability company, limited partnership, corporation or business trust that owns Texas real estate is a taxable entity, and the Comptroller's FAQ confirms that a single-member LLC filing as a sole proprietor federally is still taxable, as is a family limited partnership unless it qualifies as passive.
Most small landlords owe nothing because of the no-tax-due threshold: $2,650,000 of annualized total revenue for reports due in 2026 and 2027, up from $2,470,000 for 2024 and 2025. Entities at or below the threshold no longer file a No Tax Due Report but must still file the annual Public Information Report or Ownership Information Report. Above the threshold the tax is 0.75 percent of margin, or 0.375 percent for retail and wholesale businesses.
A sale year deserves a second look. Ask your CPA whether the proceeds or gain push the entity's total revenue over the threshold for that report year, because the answer turns on how the sale is reported federally, and a completed exchange changes what appears on the federal return.
The passive-entity exclusion in §171.0003 is narrower than its name. Only a general or limited partnership or a non-business trust can qualify, at least 90 percent of federal gross income must come from listed passive sources, and while capital gains from the sale of real property are on the list, rent is expressly not.
Depreciation recapture taxed as ordinary income is not passive either. An LLC can never be a passive entity, and a passive partnership registered with the Secretary of State still files a report each year to affirm its status.
Article VIII, Section 29: no transfer tax on a fee simple conveyance
Section 29 of Article VIII, added November 3, 2015, provides that after January 1, 2016 no law may impose a transfer tax on a transaction that conveys fee simple title to real property. Texas closings therefore carry county recording fees and title premiums but no deed stamp, documentary stamp or mortgage tax, whether or not the deed is part of an exchange.
That makes Texas replacement property cheaper to record than replacement property in Tennessee, Vermont or most other states, and it means the only state-level number to model on the way in is the property tax.
Appraisal districts, the 20 percent circuit breaker and what a sale does to value
Texas has no state property tax; each county appraisal district appraises property at market value as of January 1, and the appraisal review board begins hearing protests around May 15. There is no acquisition-value rule, but a recent sale price is the most direct evidence of market value the chief appraiser has, and buyers of income property should expect the next notice to reflect it.
The 10 percent annual cap in Tax Code §23.23 protects only residence homesteads. For everything else, Senate Bill 2 (2023) created a temporary circuit breaker in §23.231: for real property whose appraised value was $5 million or less when it first qualified (the 2024 figure, indexed by the Comptroller each year), the appraised value may rise no more than 20 percent a year plus the value of new improvements. The limitation takes effect January 1 of the year after the first year the owner owns the property on January 1, and it expires December 31, 2026; the Comptroller's January 2026 Property Tax Basics still shows that expiration date.
For a buyer of Texas replacement property in 2026, the practical reading is that the circuit breaker will not help unless the Legislature extends it, so underwrite the property at full market value. If you are selling land appraised as open-space agricultural land, §23.55 imposes a rollback of three years of tax difference when the use changes, and a lien attaches on the date of the change.
Replacement property
A DST as replacement property for a Texas seller
Revenue Ruling 2004-86 lets a Texas seller exchange into a Delaware statutory trust interest as though it were real estate, provided the trust is structured as the ruling describes. Breakwater Exchange's traditional DST and cash-out DST offerings come from vetted national sponsors, and the investment types page describes the other structures we broker.
Texas adds no tax when you buy: no transfer tax, no income tax on the distributions, and no franchise tax for an individual investor, because a natural person is not a taxable entity. If your Texas LLC holds the DST interest instead, it remains a taxable entity that files annually even when it owes nothing under the threshold.
The other states are the issue. DST properties are often in income-tax states, and because DST investors are taxed as direct owners, your share of rents and gain is generally sourced to those states, each of which may require a nonresident return. A Dallas investor used to filing only a federal return should have a CPA price that compliance before choosing among sponsors, and may prefer sponsors whose properties sit in states without an income tax.
Questions investors ask about 1031 exchanges in Texas
Does Texas tax the gain on an investment property sale if I skip the exchange?
No. The Texas Constitution prohibits an individual income tax (Art. VIII §24-a) and, since November 4, 2025, a capital gains tax (§24-b), so the gain is taxed federally only.
My rental is in a single-member LLC. Does the LLC owe Texas franchise tax in the year it sells?
It is a taxable entity and must file, but it owes tax only if its annualized total revenue exceeds $2,650,000 for the 2026 or 2027 report year; below that it files the Public Information Report only. Have your CPA check whether the sale changes that.
Can my rental partnership avoid franchise tax as a passive entity?
Only if it is a partnership or non-business trust with at least 90 percent of federal gross income from listed passive sources; rent is excluded from that list under §171.0003(b), so a partnership living on rent will not qualify, though gain on the sale of real property does count.
Is there a Texas transfer tax or stamp tax when I deed my property to the buyer?
No. Article VIII, Section 29 bars any transfer tax on a conveyance of fee simple title enacted after January 1, 2016, so you pay recording fees only.
Will the 20 percent circuit breaker protect the Texas replacement property I buy in 2026?
Not on the current statute. The limitation starts January 1 of the year after your first January 1 of ownership, and §23.231 expires December 31, 2026, so a 2026 purchase gets no benefit unless the Legislature extends the provision.
Does Texas withhold anything from a nonresident seller at closing?
No. Texas has no income tax and no real estate withholding, so every dollar of net proceeds reaches the exchange account.
Sources
The rules above were checked against these publications on September 18, 2026. Rates and forms change; confirm the current version with your CPA and the Texas tax agency before you close. This page is general information, not tax or legal advice.
- Texas Constitution, Article VIII §§24-a, 24-b and 29 (Texas Legislative Council)
- Texas Comptroller, Franchise Tax (rates, thresholds and reporting)
- Texas Comptroller, Franchise Tax FAQ: Passive Entities
- Texas Comptroller, Franchise Tax FAQ: Taxable Entities
- Texas Tax Code §171.0002 and §171.0003
- Texas Tax Code §23.23, §23.231 and §23.55
- Texas Comptroller, Texas Property Tax Basics (January 2026)
- IRS Revenue Ruling 2004-86 (Delaware statutory trusts and §1031)