1031 Exchange Formula

Most 1031 exchange articles explain the timeline. Far fewer explain the actual math that determines how much of your gain you defer versus how much becomes taxable this year. This guide walks through that math step by step. It's educational, not tax advice — always have your CPA run your actual numbers before you rely on any of this.

Step 1: Find Your Adjusted Basis

Adjusted Basis = Original Purchase Price + Capital Improvements − Depreciation Taken

This is your starting point for every calculation that follows. Capital improvements add to basis; routine repairs and maintenance do not. Depreciation you've claimed over the years reduces your basis — which is exactly why depreciation recapture (below) matters.

Step 2: Calculate Realized Gain

Realized Gain = Net Sale Price − Adjusted Basis

Net Sale Price is your gross sale price minus selling costs (commissions, closing costs). This is the total gain the transaction has generated — not necessarily the amount that gets taxed.

Step 3: Identify "Boot" — What Actually Gets Taxed

"Boot" is anything of value you receive out of the exchange that isn't like-kind real property. If you receive boot, some or all of your realized gain becomes recognized (taxable) this year. There are two common kinds:

• Cash boot: Any sale proceeds you take out rather than reinvest — including leftover funds your QI returns to you at the end of the exchange period.
• Mortgage (debt) boot: If the debt paid off on your relinquished property is greater than the debt you take on with the replacement property, that net debt reduction is treated as boot — unless you offset it with additional cash brought to the purchase.

Recognized (Taxable) Gain = the LESSER of Realized Gain or Total Boot Received

In other words, you're never taxed on more than your actual gain, but any boot you take will trigger tax up to that amount even if the rest of the gain is deferred.

Step 4: The Equal-or-Up Test

To defer 100% of your gain — zero boot — two things generally need to be true:

• Replacement property value ≥ Relinquished property net sale price
• Replacement property debt ≥ Relinquished property debt paid off (or you make up any shortfall with additional cash)

Buy something cheaper, or take on less new debt than you paid off without covering the gap in cash, and you'll generate boot — even though you technically completed an exchange.

Step 5: Don't Forget Depreciation Recapture

If you claimed depreciation on the relinquished property, that portion of your gain is subject to separate depreciation recapture treatment when it's eventually recognized (either from boot now, or from a future non-exchange sale). Recapture is generally taxed differently — and often at a different rate — than ordinary long-term capital gains. Your CPA needs your full depreciation schedule to calculate this correctly; don't estimate it yourself for planning purposes.

Worked Example (Illustrative Numbers Only)

To fully defer the $260,000 realized gain, the replacement property needs a purchase price of at least $500,000, financed with at least $180,000 in new debt (or the equivalent made up in additional cash), with no sale proceeds pocketed along the way. If this investor instead bought a $420,000 replacement with $150,000 in new debt and pocketed $80,000 in cash, that $80,000 in cash boot (plus any debt-reduction boot) would become taxable this year — with the rest of the $260,000 gain still deferred.

Frequently Asked Questions

Q: If I receive some cash boot, does that disqualify the whole exchange?
A: No. The exchange still stands — you simply owe tax on the amount of boot received (up to your total realized gain), while the remaining gain stays deferred.

Q: Does paying off a bigger mortgage than I take on always create taxable boot?
A: Generally yes, unless you bring additional cash to the replacement purchase to offset the reduction in debt.

Q: Is depreciation recapture taxed at the same rate as my capital gain?
A: Typically not — recapture on real property is usually taxed differently from the rest of the long-term capital gain. Rates and rules can change, so confirm the current treatment with your CPA rather than relying on a rule of thumb.