What a 1031 exchange defers
When you sell an investment property outright, you generally owe federal tax on the gain, including depreciation recapture, plus the 3.8% net investment income tax for many owners and state income tax where it applies. A 1031 exchange lets you roll the proceeds into like-kind real estate held for investment and push that tax into the future instead of paying it at closing.
The tax is deferred, not forgiven. Your old basis carries into the new property, so the deferred gain is still there if you later sell without exchanging again. For many owners, though, the ability to keep the entire equity working in a larger or better-located building is the whole point.
The two tests for full deferral
To defer all of the gain, an exchange generally has to pass two tests. The calculator checks both and shows you where any shortfall lands.
- Reinvest all of the net equity. Cash left over after the replacement purchase — whether you take it home or simply do not need it — is cash boot and is taxable up to the amount of your gain.
- Replace the debt you paid off. If your new loan is smaller than the mortgage that was retired at the sale, the difference is mortgage boot unless you make it up by adding fresh cash to the purchase.
- In practice, buying a replacement property worth at least the net sale price and putting all of the equity into it usually satisfies both tests.
How the calculator works
It follows the same arithmetic a CPA or qualified intermediary would run on a straightforward exchange:
- Amount realized is the sale price minus selling costs.
- Adjusted basis is what you paid plus capital improvements, minus the depreciation you have taken.
- Realized gain is the amount realized minus adjusted basis.
- Net equity is the amount realized minus the mortgage paid off at closing. Equity required is the replacement price minus the new loan.
- Cash boot is net equity you do not reinvest. Mortgage boot is debt relief not covered by the new loan or by extra cash you add.
- Recognized (taxable) gain is the smaller of total boot and realized gain. The rest is deferred. Tax on the recognized portion is estimated with depreciation recapture first at up to 25%, then your capital gains rate, the optional 3.8% surtax and your state rate.
- The basis of the replacement property is its price minus the deferred gain.
A worked example
An owner sells a building for $3,200,000 with $120,000 of selling costs, so the amount realized is $3,080,000. They bought it for $1,800,000, added $250,000 of improvements and have taken $520,000 of depreciation, for an adjusted basis of $1,530,000 and a realized gain of $1,550,000. Paying off the $1,400,000 mortgage leaves $1,680,000 of net equity.
They buy a $3,500,000 replacement building with a $1,900,000 loan, which needs $1,600,000 of equity. The $80,000 they do not reinvest is cash boot. The new loan is larger than the old one, so there is no mortgage boot. Only $80,000 of the gain is taxable; roughly $1,470,000 is deferred, and the replacement property starts with a basis of about $2,030,000.
The deadlines that make or break an exchange
The arithmetic is the easy part. The calendar is where exchanges fail. From the day the relinquished property closes, you have 45 days to identify replacement property in writing and 180 days to close on it, and neither deadline is extended for weekends or holidays. A qualified intermediary must hold the sale proceeds; if the money reaches your own account, the exchange is generally broken.
Plan the replacement search before you list, line up financing early, and build closing flexibility into the sale contract. Buyers who understand exchanges — including Skyline — can often adjust a closing date so your 45-day clock starts when you are ready.
Limits of this estimate
Real exchanges have details a calculator cannot see: exchange expenses that can be paid from proceeds, partial-year depreciation, state clawback rules, installment notes, related-party restrictions, and how boot is characterized between recapture and capital gain. Use the result to compare scenarios and to prepare questions for your CPA and qualified intermediary, not as a tax return.
