Partial Exchange Example: The Tax on $150K of Boot, Layer by Layer

Section 1031(b) taxes boot up to the gain, so $150,000 out means $150,000 recognized on any property with a large gain

Section 1031(b) keeps an exchange valid when you also receive money, and recognizes gain 'in an amount not in excess of the sum of such money and the fair market value of such other property.' The rest of the gain stays deferred. On a property with $1,000,000 of realized gain, $150,000 of cash means exactly $150,000 of recognized gain.

The Form 8824 instructions put the boot on line 15 and the recognized gain on line 20, the smaller of line 15 or the realized gain on line 19. Line 15 is reduced by exchange expenses you paid, so commissions and closing costs paid from the sale reduce the boot that is taxed.

Boot is not only cash. Under Reg. section 1.1031(d)-2, debt paid off at the sale and not replaced is treated like money received. Cash you add offsets debt relief, but new debt you take on never offsets cash you keep, as whether more debt offsets cash taken out explains.

The $150,000 fills the most expensive layer first: ordinary recapture, then the 25% slot, then capital gain

Form 8824 line 21 takes any ordinary-income recapture off the top of the recognized gain, which matters if a cost segregation study put section 1245 components on your books. On a building depreciated straight line there is usually none, because Publication 544 limits section 1250 ordinary recapture to depreciation above straight line.

What is left is long-term gain, and the part attributable to depreciation is unrecaptured section 1250 gain under section 1(h)(6), taxed at ordinary rates capped at 25%. Section 1250(d)(4) ties the recapture amount in an exchange to the gain recognized, so with $400,000 of depreciation behind it, all $150,000 lands in the 25% slot and none reaches the 15% or 20% rate.

The ordering argument is set out in whether boot is taxed as recapture or capital gain first. The practical point for this page is that the first $400,000 of boot on this property would all be taxed at up to 25%.

Worked example: $1.5 million out, $1.35 million back in, $150,000 kept

Hypothetical: a couple filing jointly sells a rental for $1,560,000 and pays $60,000 of selling costs, so the amount realized is $1,500,000. They bought it for $900,000 and have taken $400,000 of straight-line depreciation, so adjusted basis is $500,000 and realized gain is $1,000,000. There is no mortgage. They buy a $1,350,000 replacement and take $150,000 at closing.

Household A has $450,000 of other taxable income. The $150,000 stacks into the 32% and 35% brackets, so the 25% cap applies: $37,500. Net investment income tax adds 3.8% of $150,000, or $5,700, and a hypothetical 5% state tax adds $7,500. Total: $50,700, a 33.8% bite, leaving $99,300.

Household B has $100,000 of other taxable income. Using the 2026 joint brackets in Rev. Proc. 2025-32, $800 of the layer falls at 12%, $110,600 at 22% and $38,600 at 24%, for $33,692. MAGI of $250,000 does not exceed the threshold, so there is no surtax. With $7,500 of state tax, the total is $41,192, leaving $108,808.

For comparison, Household A selling outright would owe $100,000 on the $400,000 depreciation layer, $120,000 at 20% on the remaining $600,000, $38,000 of surtax and $50,000 of hypothetical state tax: $308,000. The partial exchange pays $50,700 now and defers $257,300. Run your own numbers with your CPA.

The deferred gain and the remaining depreciation layer move into the replacement's basis

Section 1031(d) sets the replacement's basis at the old basis, decreased by money received and increased by gain recognized: $500,000 minus $150,000 plus $150,000, or $500,000. The check is simple: the $1,350,000 replacement less the $850,000 of deferred gain is $500,000.

The $250,000 of depreciation that the boot did not use stays inside the deferred gain. When the replacement is eventually sold for cash, that amount is still taxed in the 25% layer, along with any depreciation you take on the replacement. Depreciating the replacement shows how the carried-over basis is depreciated.

If the boot had come from debt relief instead of cash, for example a $400,000 loan paid off and only $250,000 of new debt placed, the same $150,000 would be taxed, with no cash in hand to pay it. Adding $150,000 of your own money at the replacement closing would cure that, because cash paid offsets debt relief.

How to take the cash so the $150,000 is the only boot

The cleanest route is to have the settlement statement pay the $150,000 to you at the sale closing and send the balance to the qualified intermediary. Once money is with the intermediary, Reg. section 1.1031(k)-1(g)(6) generally prevents its release until the exchange ends, and cash paid out in the following tax year can shift the gain into that year, which the tax-year straddle covers.

Size the replacement so that closing costs and prorations do not create extra boot. A fractional interest such as a Delaware statutory trust can be bought in an exact dollar amount, which makes it easier to reinvest everything except the $150,000. Whether boot is worth taking at all is weighed in intentional boot as a strategy.