Can You Take Some Cash from a 1031 Exchange and Reinvest the Rest?

Yes, you can take some of the proceeds from a 1031 exchange and use the rest to purchase a replacement property, but any funds not reinvested are considered boot and are subject to taxes.

What Is Boot in a 1031 Exchange?

Boot refers to any portion of the 1031 exchange proceeds that is not reinvested into the replacement property. The IRS treats boot as taxable income, meaning you may owe capital gains tax, depreciation recapture tax, and potentially state taxes on the amount received.

Taking cash from a 1031 exchange

Types of Boot in a 1031 Exchange

There are three main types of boot that could trigger a tax liability:

  1. Cash Boot

    • If you receive cash from the sale of the relinquished property and do not reinvest it, that portion is taxable as capital gains.

  2. Mortgage Boot (Debt Relief Boot)

    • If the new mortgage on the replacement property is less than the mortgage on the relinquished property, the difference is considered mortgage boot and taxable.

  3. Non-Like-Kind Property

    • If you receive personal property, cash equivalents, or any non-like-kind asset, it is considered boot and is subject to taxation.
Mortgage boot in a 1031 exchange

Tax Consequences of Taking Cash Out in a 1031 Exchange

If you withdraw any proceeds instead of reinvesting them, you may owe the following taxes:

  1. Capital Gains Tax

    – Based on your income, you may be taxed at 0%, 15%, or 20%.

  2. Depreciation Recapture Tax

    – Any depreciation claimed on the relinquished property is taxed at 25%.

  3. Net Investment Income Tax (NIIT)

    – If your adjusted gross income (AGI) exceeds $200,000 (single) or $250,000 (married filing jointly), a 3.8% tax applies.

  4. State Capital Gains Tax

    – Some states charge capital gains taxes (e.g., California at 9.3%).
Investor managing 1031 exchange proceeds

Example:

How Much Tax Would You Pay If You Take Cash Out?

Let’s say you sell a property for $1,000,000 with an original purchase price of $600,000 and have $100,000 in depreciation. Your old mortgage was $200,000, and your new mortgage is $150,000.

Taxable Boot Calculation:

  • Cash Boot: $100,000 (taxable)
  • Mortgage Boot: $200,000 (old mortgage) – $150,000 (new mortgage) = $50,000 (taxable)
  • Total Boot: $100,000 (cash) + $50,000 (mortgage) = $150,000 (taxable income)

Taxes Owed on Boot:

  • Capital Gains Tax (15%): $150,000 × 15% = $22,500
  • Depreciation Recapture Tax (25%): $100,000 × 25% = $25,000
  • Net Investment Income Tax (3.8%): $150,000 × 3.8% = $5,700
  • State Capital Gains Tax (e.g., California at 9.3%): $150,000 × 9.3% = $13,950

Total Taxes Owed: $67,150

How to Minimize or Avoid Boot in a 1031 Exchange

To defer all taxes in a 1031 exchange, follow these strategies:

  • Reinvest All Proceeds – Use 100% of the sale proceeds to purchase the replacement property.
  • Match or Increase Debt – Ensure the mortgage on the new property is equal to or greater than the old one.
  • Avoid Cash Withdrawals – Any cash taken from the exchange will be taxable.
Cash boot tax consequences

Should You Take Cash Out in a 1031 Exchange?

While you can take some proceeds from a 1031 exchange, doing so will trigger capital gains taxes, depreciation recapture, and possibly state taxes. To fully defer taxes, you must reinvest all proceeds and ensure the new property meets 1031 exchange requirements.

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taxable boot calculation