1031 Exchange
How much tax can you defer by trading up?
NIIT applies (3.8%)
MAGI > $200k single / $250k MFJ
Tax you defer with a 1031
$138,624
That’s the tax bill you’d owe on a straight sale of this property. Doing a 1031 lets you push it to a future sale (or never, if you hold to death, heirs get stepped-up basis). With a 1031, you have $590,500 available to invest vs $451,876 after-tax, a buying-power difference of $554,496 at typical investor leverage (75% LTV).
Sale price
$850,000
Selling costs
$59,500
7% commissions/closing
Adjusted basis
$330,000
cost + improvements − depreciation
Total taxable gain
$460,500
before any deferral
Depreciation recapture
$120,000
taxed @ max 25% + 3.8% NIIT
Remaining LTCG
$340,500
taxed @ 20% + 3.8% NIIT
Total tax (no exchange)
$138,624
fed + state + recapture
Tax deferred via 1031
$138,624
pushed to future sale
How a 1031 exchange works
You sell investment property and defer the cap gains and depreciation recapture taxes by reinvesting the proceeds in like-kind investment property. "Like-kind" is broadly interpreted. Almost any US real estate held for investment/business qualifies (residential rental, commercial, raw land, etc.).
The two deadlines (strict, no extensions):
• 45 days after sale to identify replacement property in writing
• 180 days after sale to close on the replacement (or your tax return due date, with extensions, if earlier)
You can’t touch the money: proceeds must go directly to a Qualified Intermediary (QI). If you receive cash, even briefly, you blow the exchange.
Trade equal or up: the replacement price must be ≥ the net sale price (sale price minus selling costs), you must reinvest all the exchange cash, and the debt paid off at sale must be replaced, either with a new mortgage or with extra cash you add (added cash can offset debt relief, but new debt can’t offset cash you take out). Anything less = "boot" = taxable to that extent. The math above assumes all QI cash goes into the replacement, so total boot is how far the replacement price falls short of the net sale price.
Heirs get stepped-up basis: if you keep exchanging until death, your heirs inherit at fair market value, wiping out all deferred gain. This is why some investors do exchange after exchange.
Costs: QI fees ($1,000-2,500). Hire a 1031-experienced QI; never self-direct. Also work with a CPA. Getting it wrong = full taxation + penalties.
Doesn’t model: cash held back from the QI (cash boot beyond the price shortfall), replacement closing costs, reverse exchanges, build-to-suit exchanges, related-party rules, foreign property exclusion, vacation home complexity. Talk to a 1031 QI and CPA before a real exchange.