Partial 1031 Exchange: How Taking Cash Out Works
A partial 1031 exchange is an ordinary 1031 exchange in which you deliberately don’t reinvest everything — you buy a cheaper replacement property, take some cash off the table, or replace less debt than you paid off. The exchange stays valid; under IRC §1031(b), you simply recognize gain up to the amount of money and non-like-kind property (boot) you receive, and the rest of your gain stays deferred. There is no separate “partial exchange” section of the tax code — it’s the same statute, with boot in the mix.
What makes an exchange “partial”
A fully deferred exchange requires that, in practice, you buy replacement real estate worth at least as much as what you sold, reinvest all the exchange proceeds, and replace the debt (or offset any debt shortfall with new cash). Fall short on any of those, and the difference comes back to you as boot:
| You… | Result |
|---|---|
| Buy a replacement property cheaper than what you sold (“exchanging down”) | The trade-down amount typically comes back as taxable boot |
| Instruct the qualified intermediary to release some cash to you | Cash boot in that amount |
| Take on less debt than you paid off, without adding cash to cover the gap | Mortgage (debt-relief) boot for the net reduction |
The statutory rule is short: if an exchange would otherwise qualify but you also receive money or other non-qualifying property, “the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property” (IRC §1031(b)). Two consequences:
- Boot doesn’t invalidate the exchange. Only the boot portion is taxed; the balance of the gain remains deferred.
- Recognized gain is capped at your realized gain. If your total gain is $80,000 and you take $120,000 of cash out, you recognize $80,000 — never more than the actual gain. (Which also means that once boot equals or exceeds your realized gain, the exchange defers nothing, and you’ve paid exchange fees for no tax benefit.)
One asymmetry: boot can trigger gain, but it never lets you deduct a loss — IRC §1031(c) bars loss recognition in a partially non-like-kind exchange.
How cash and debt net against each other (new debt offsets old debt; cash you add offsets debt relief; but new debt cannot offset cash you take out) is covered in detail in our guide to boot in a 1031 exchange.
How the cash you take out is taxed
Boot is recognized gain in the year of the exchange, reported on IRS Form 8824 — the form caps recognized gain at the smaller of the boot received or your total realized gain. The character of that gain is where partial exchanges surprise people:
- Depreciation-related gain comes out first. Form 8824 has a dedicated line (line 21) for gain taxed as ordinary income under the section 1245 and 1250 recapture rules. For real estate depreciated straight-line, the depreciation-attributable portion of your recognized gain is generally unrecaptured section 1250 gain, “taxed at a maximum 25% rate” rather than the 0/15/20% long-term capital gains rates (IRS Topic 409). See 1031 exchanges and depreciation recapture.
- The remainder is capital gain — long-term if you held the relinquished property more than a year — and may also attract the 3.8% net investment income tax and state income tax. State treatment of exchanges and boot varies; see our 1031 exchange by state guides.
Because the higher-rate, recapture-flavored gain is recognized before any lower-rate capital gain, the effective tax rate on a “small” cash-out is often higher than investors expect. Model it before you commit, not after.
Basis of the replacement property
In a partial exchange, your deferred gain doesn’t disappear — it’s preserved in a reduced basis. Under IRC §1031(d), the replacement property’s basis equals the basis of the property you gave up, decreased by any money you received and increased by any gain you recognized. Form 8824 line 25 computes the same result (instructions).
The practical effect: taking boot and paying tax on it doesn’t raise your basis beyond what the boot itself accounted for. The deferred gain is still embedded in the new property and will surface on a later taxable sale — unless you exchange again, or hold until death, when heirs generally receive a basis stepped up to fair market value under IRC §1014. Deeper dive: 1031 exchange basis rules.
Worked example (hypothetical illustration)
The numbers below are round, hypothetical figures for illustration only — not a real transaction — and they ignore closing costs and exchange expenses to keep the arithmetic clean.
An investor sells a rental property and deliberately takes $100,000 out:
| Item | Amount |
|---|---|
| Sale price of relinquished property | $800,000 |
| Adjusted basis | $350,000 |
| Realized gain (800,000 − 350,000) | $450,000 |
| Mortgage paid off at sale | $300,000 |
| Net proceeds held by the qualified intermediary | $500,000 |
| Purchase price of replacement property | $700,000 |
| New mortgage on replacement property | $300,000 |
| Exchange cash used at purchase (700,000 − 300,000) | $400,000 |
Boot calculation:
- Cash boot: $500,000 held by the QI − $400,000 reinvested = $100,000 returned to the investor.
- Mortgage boot: $300,000 of debt relief − $300,000 of new debt = $0.
- Total boot: $100,000 — exactly the trade-down from $800,000 to $700,000.
Result: the investor recognizes $100,000 of gain (less than the $450,000 realized gain) and defers the remaining $350,000. If the investor had claimed, say, $120,000 of straight-line depreciation, the entire $100,000 recognized would generally be unrecaptured section 1250 gain taxed at up to 25% federally — up to $25,000 — plus any net investment income tax and state tax.
Replacement basis check (§1031(d)): $350,000 old basis − $100,000 money received + $100,000 gain recognized = $350,000. Equivalently: $700,000 purchase price − $350,000 deferred gain = $350,000. The deferred gain is fully preserved in the new property.
Run your own numbers with our 1031 exchange calculator.
Every other exchange rule still applies
A partial exchange gets no procedural discount. Under Treas. Reg. §1.1031(k)-1 you must still:
- Use the qualified-intermediary safe harbor and avoid actual or constructive receipt of proceeds mid-exchange. During the exchange period, the agreement must bar you from receiving, pledging, or borrowing against the funds — the QI can typically release your planned cash-out only at closing on the relinquished property (before funds enter the exchange account) or per the agreement’s limited release provisions, which is why the amount should be decided before closing with your advisor.
- Identify replacement property within 45 days of transferring the relinquished property, in writing, under the 3-property rule, the 200% rule, or the 95% exception.
- Close within the exchange period — the earlier of 180 days after transfer or the due date (including extensions) of your tax return for the year of the sale.
Details on the deadlines: the 45-day rule and 180-day rule.
When a partial exchange makes sense
Taking boot on purpose is a legitimate strategy, not a failed exchange. Common reasons:
- Liquidity. You need cash for reserves, another business, tuition, or paying down unrelated debt, and you’re willing to pay tax on just that slice while deferring the rest.
- Diversification. Roll most of the equity into replacement real estate and move some out of the asset class entirely. (Investors who want diversification within the exchange sometimes use fractional interests such as a Delaware statutory trust instead, which keeps those dollars deferred.)
- Right-sizing. The replacement property you actually want costs less than what you sold, and the tax on the trade-down is acceptable.
- Small remaining gain. If boot would consume most of your realized gain anyway, compare the tax deferred against the exchange’s cost and constraints — sometimes a straight sale is simpler.
The math is rarely intuitive because of the recapture ordering and netting rules, so price out the tax on the exact boot amount with a professional before you close.
The alternative: refinance after the exchange
If your real goal is cash rather than a smaller property, the commonly discussed alternative is a fully deferred exchange followed by a refinance of the replacement property. Loan proceeds aren’t taxable income — as qualified intermediary Accruit explains, “a fundamental reason why borrowing money does not create income is that the money has to be repaid and therefore does not constitute a net increase in wealth,” and in its view refinancing the replacement property after the exchange “should not jeopardize the tax deferral on the transaction.”
Timing is the sensitive part. There is limited direct IRS guidance on post-exchange refinancing, and practitioners caution against a cash-out refinance that is prearranged before, or closed concurrently with, the replacement purchase — the concern being that the IRS could argue it’s really one step in taking untaxed cash out of the exchange (a step-transaction argument). Views differ on how long to wait and how much separation is enough, so treat this as a strategy to structure with your tax advisor, documenting an independent business purpose for the loan. Note also that you cannot borrow against or pledge the exchange funds themselves while the QI holds them (Treas. Reg. §1.1031(k)-1(g)(6)). More in our guide to cash-out refinancing around a 1031 exchange.
Frequently asked questions
Yes. There's no separate 'partial exchange' provision — IRC §1031(b) simply provides that if you receive money or non-like-kind property in an otherwise qualifying exchange, you recognize gain up to that amount and the rest stays deferred. The exchange remains valid; only the boot portion is taxed.
The cash (boot) is recognized gain, capped at your total realized gain and reported on Form 8824. Depreciation-related gain is taxed first — for straight-line-depreciated real estate, generally as unrecaptured section 1250 gain at up to 25% federally — with the remainder taxed as capital gain, potentially plus the 3.8% net investment income tax and state tax. The blended rate is often higher than investors expect.
Yes, in full. You must identify replacement property in writing within 45 days of transferring the relinquished property and acquire it by the earlier of 180 days after transfer or the due date (including extensions) of your tax return, under Treas. Reg. §1.1031(k)-1. Taking boot doesn't relax any procedural requirement.
Under IRC §1031(d), the replacement property's basis equals your old basis, decreased by money received and increased by gain recognized. The deferred gain stays embedded in the new property as a reduced basis and surfaces on a later taxable sale — unless you exchange again or hold until death, when heirs generally receive a stepped-up basis under IRC §1014.
Boot is taxable; loan proceeds from a refinance are not, because they must be repaid. Many practitioners therefore prefer a fully deferred exchange followed by a post-closing refinance of the replacement property — but a refinance that's prearranged or closed simultaneously with the exchange can invite step-transaction scrutiny, and IRS guidance is limited. Structure the timing with a tax professional.
This article is for educational purposes only and is not legal or tax advice. Partial exchanges, boot, and basis are governed by IRC §1031 and the Treasury Regulations; consult a qualified tax professional or attorney about your specific situation.
Primary sources: IRC §1031 (Cornell LII) · IRC §1014 (Cornell LII) · Treas. Reg. §1.1031(k)-1 (Cornell LII) · IRS Form 8824 & Instructions · IRS Topic 409, Capital Gains and Losses · Accruit, “Cash Out Refinance Before or After a 1031 Exchange?”