1031 Exchange Tax Implications: Depreciation Recapture, Basis and Boot

Written by Chris Peterson, Texas-licensed attorney | Last substantively reviewed August 2026

A properly structured 1031 exchange generally defers gain on the sale of investment or business real estate. That can include capital gain and the depreciation-related portion of the gain. The tax is deferred, not erased. It follows you into the replacement property through its basis.

The details matter. If you receive cash, reduce debt without replacing it, or exchange property with certain depreciable components, some tax may be due now. Your qualified intermediary structures the exchange. Your CPA calculates the tax result.

The short answer

What taxes can a 1031 exchange defer?

A qualifying exchange can defer the federal gain that would otherwise be recognized on a taxable sale. Depending on your facts, that may include:

• Long-term capital gain on appreciation.
• Depreciation-related gain, often described as depreciation recapture.
• The 3.8% net investment income tax to the extent it applies to deferred gain.
• State income tax in states that follow the federal exchange treatment.

State rules are not identical. Some states require withholding forms, annual tracking reports or later recognition of in-state gain. If your relinquished and replacement properties are in different states, bring your tax advisor into the conversation before closing.

How depreciation changes the tax calculation

Depreciation gives you deductions while you own a rental or business property. Those deductions also reduce your adjusted basis. A lower basis means a larger realized gain when you sell.

People often call the depreciation-related part of a real-estate gain “depreciation recapture.” Technically, gain tied to straight-line depreciation on most real property is commonly treated as unrecaptured Section 1250 gain. It may be taxed at a maximum 25% federal rate. Other components, including certain items identified in a cost-segregation study, can follow different recapture rules.

That distinction matters when you calculate tax. It does not change the practical planning point. Prior depreciation can create a meaningful tax exposure, and a qualifying 1031 exchange can often defer it.

A simple adjusted-basis example

Assume you bought a rental property for $300,000 and later claimed $100,000 of depreciation. Ignore improvements, debt and transaction costs. Your adjusted basis is $200,000. You later sell the property for $500,000. The entire $500,000 is transferred through your qualified intermediary.

Step	Amount
Original cost basis	$300,000
Less depreciation claimed or allowable	($100,000)
Adjusted basis	$200,000
Net amount realized on sale	$500,000
Realized gain	$300,000

Without an exchange, the $300,000 realized gain must be analyzed by character. Part may be taxed at capital-gain rates, part may fall under depreciation-related rules, and other federal or state taxes may apply.

How carryover basis keeps the tax deferred

You add $100,000 to acquire a $600,000 replacement property. You receive no cash or other non-like-kind property. In this simplified example, the replacement property’s basis is $300,000:

Calculation	Amount
Cost of replacement property	$600,000
Less deferred gain	($300,000)
Approximate replacement-property basis	$300,000

The $300,000 deferred gain has not disappeared. It is embedded in the new property’s lower basis. If you later sell the replacement property without another exchange, that lower basis helps determine the gain you recognize at that time.

This is a simplified illustration. Actual basis calculations can include exchange expenses, recognized gain, liabilities, multiple assets, depreciation conventions and other adjustments. Your tax advisor should calculate the final numbers.

When can tax be due during the exchange?

A 1031 exchange does not have to be all or nothing. You can complete a partial exchange, but the portion that is not deferred may be taxable.

Cash or non-like-kind property

If you receive cash or other non-like-kind property, the IRS generally recognizes gain up to the value received. Investors often call this boot.

Debt relief

Debt matters because paying off the old loan is part of the exchange math. Buying down in value or reducing debt without adding enough cash can create taxable gain. Do not wait until the replacement closing to discover a shortfall.

Depreciable components

Most investors are exchanging real estate, but a building can contain components with different depreciation treatment. IRS Publication 544 explains that certain Section 1245 or Section 1250 recapture may be recognized even when other gain is deferred. This issue is especially important after a cost-segregation study or accelerated depreciation.

How Form 8824 reports the result

You report a like-kind exchange on Form 8824 for the tax year in which you transfer the relinquished property. The form calculates realized gain, recognized gain, deferred gain and the basis of the replacement property.

Your qualified intermediary provides exchange agreements, assignments, notices and closing documentation. Your CPA or tax preparer uses those documents with your basis and depreciation records to complete the return. Keep both closing statements and your historical depreciation schedules.

What happens when you later sell?

You have three common paths:

1. Sell without another exchange. The accumulated deferred gain may become taxable based on the replacement property’s adjusted basis and the character of the gain.
2. Complete another 1031 exchange. A new qualifying exchange can continue the deferral.
3. Hold the property as part of a long-term estate plan. Under current federal law, inherited property may receive a basis adjustment at death. Estate planning rules and tax law can change, so coordinate this strategy with your attorney and tax advisor.

Questions to answer before you list

• What is your current adjusted basis?
• How much depreciation have you claimed, including cost-segregation or bonus depreciation?
• How much cash do you want to keep after closing?
• What debt will be paid off, and how will you fund the replacement purchase?
• Are the properties in different states?
• Can your qualified intermediary be in place before the sale closes?

If you are already under contract, start the conversation now. Once you receive or control the sale proceeds, it is generally too late to turn the transaction into a deferred exchange.

Frequently asked questions

Does a 1031 exchange eliminate depreciation recapture?

No. A qualifying exchange generally defers the depreciation-related gain rather than eliminating it. The deferred gain follows the transaction through the replacement property’s basis. Cash, non-like-kind property and certain depreciable components can still create current tax.

Do I pay tax if I receive cash from the exchange?

Possibly. Cash you receive is generally taxable up to the gain realized. A partial exchange can be a valid strategy, but you should know the tax cost before closing.

Does buying a more expensive property guarantee full deferral?

Not by itself. Value, net equity, debt and closing-statement items all affect the calculation. Review both settlement statements with your tax advisor and qualified intermediary before you close.

Can a qualified intermediary calculate my tax bill?

A qualified intermediary can explain exchange mechanics and help you track proceeds and timing. Your CPA or tax advisor should calculate basis, gain character and the tax due for your specific facts.

Do I still file Form 8824 if the exchange is fully deferred?

Yes. Form 8824 reports the exchange and calculates the deferred gain and replacement-property basis even when no gain is recognized currently.

Plan the exchange before the sale closes

The question is not simply, “Can I defer tax?” The better question is, “How much can I keep invested, and what must be true for the deferral to work?”

WealthBuilder 1031 can coordinate the exchange documents, safeguard the proceeds and keep the exchange on schedule. Call 888-508-1901 or visit WealthBuilder1031.com before your sale closes.

Related guides: Tax Tips for House Flippers, Installment Sales in 1031 Exchanges, 1031 Exchanges and Opportunity Zones, Are 1031 Exchange Fees Tax Deductible?