A partial 1031 exchange happens when you sell an investment property, roll most of the value into like-kind real estate, and walk away with something else as well: cash, relief from a mortgage you do not replace, or property that is not real estate. The exchange still works for the part you reinvest, and the rest is taxed. If you want some money out of a sale or the replacement you like costs less than the property you are selling, these are the rules that decide how much of your gain stays deferred.
As co-founder of Seneca Cost Segregation and a real estate investor myself, I’ve worked with owners who come to us after trading down into a smaller building or pulling cash out of an exchange, ready to have the new property studied. What we find on those properties is that the partial exchange decides more about the study than most people expect, from how much basis the engineers have to work with to whether any of it can take bonus depreciation.
Below, I walk through where boot comes from, how the taxable amount is calculated, when you can get cash out, how the recognized gain is taxed, and what a partial exchange does to depreciation on the property you buy.
TL;DR: Partial 1031 Exchange Rules
- ●You keep most of the deferral even with cash out: gain is taxed only up to the boot you receive, so a $10,000 cash draw on a sale with $25,000 of gain does not make the whole gain taxable.
- ●Debt you shed counts like cash: a mortgage the buyer takes over is treated as money you received unless you take on equal debt or add cash on the replacement.
- ●Cash you receive is never offset by new debt: a bigger mortgage on the replacement can cancel mortgage boot, while cash boot stays taxable.
- ●Leftover funds have fixed release windows: a qualified intermediary can pay out remaining cash only at points set in the regulations, and next-year cash may qualify for installment reporting.
- ●A cost segregated sale can recapture more than the boot: the IRS’s Form 8824 example reports $50,000 of ordinary income on a partial exchange that produced $40,000 of cash.
- ●Trading down can shrink bonus depreciation: on a used replacement building, only excess basis qualifies, and a trade-down can leave little or none.
How a Partial 1031 Exchange Works
In a partial exchange, you receive like-kind real property plus something that is not like-kind, and section 1031 still applies to the like-kind portion.
Why Boot Does Not Disqualify the Exchange
Section 1031(b) says that when you receive other property or money along with like-kind property, your gain is recognized, but only in an amount not exceeding the money plus the fair market value of the other property. Under section 1031(c), a loss on that kind of exchange is never recognized.
Everything else about the exchange stays the same. You still identify replacement property within 45 days and receive it by the earlier of 180 days or your return’s due date, including extensions, as IRS Publication 544 explains.
Where Boot Comes From in a Partial Exchange
Boot shows up in three forms, and many partial exchanges involve more than one of them.
Cash Kept From the Sale
Cash is the most common form of boot and the easiest to see. Any amount you take at the closing table, or receive later from funds held for the exchange, is money received under section 1031(b).
Mortgage Debt You Do Not Replace
Section 1031(d) treats a liability of yours that the other party assumes as money you received. Treasury Regulation 1.1031(d)-2 extends the same treatment to property you transfer subject to a mortgage.
When the loan on your old property is larger than the loan on your new one, that gap can be taxable even though no cash ever reaches your account.
Other Property Received in the Exchange
For exchanges after 2017, section 1031 covers only real property, so furniture, equipment, and other personal property received with the replacement building is boot. The deferred exchange regulations disregard incidental personal property for the qualified intermediary safe harbor when it is typically transferred with the real estate and is worth no more than 15% of the replacement real property, yet that property still generally produces taxable gain.
A furnished short-term rental is a common example, since the furniture usually conveys with the building, and our guide to identifying tangible personal property explains which items fall on the personal property side.
How to Calculate the Taxable Portion
Publication 544 walks through one exchange three ways, and the comparison shows how much the debt on each side changes the result.
Realized Gain and Recognized Gain
Realized gain is everything you received, including debt relief, minus exchange expenses, your adjusted basis, and any debt you take on with the replacement property. Recognized gain, the part you pay tax on now, is the smaller of the realized gain or your net boot.
In the first scenario, $25,000 of gain is realized, yet only the $5,000 left from the cash after expenses is taxed.
Offsets Between Debt and Cash
The third scenario works because debt you take on offsets debt you are relieved of. Cash you add to the purchase offsets debt relief as well.
The offset runs only one way. Example 2 in Regulation 1.1031(d)-2 states that cash or other property you receive is not offset by liabilities you assume, which is why the $10,000 of cash stays taxable even after a larger new mortgage absorbs the old one.
Exchange Expenses and Closing Items
Exchange expenses, such as brokerage commissions, attorney fees, and deed preparation fees, reduce the cash you are treated as receiving. Closing costs on the replacement purchase count too.
Publication 544 also lists closing statement items that are not exchange expenses, including property taxes, rent prorations, security deposits, and repairs. Review each line of both settlement statements with your CPA before treating any of them as a reduction in boot.
When You Can Take Cash Out of the Exchange
When you get cash matters almost as much as how much you take, because the timing rules protect the rest of the exchange and decide the tax year.
Cash at the Closing Table
The earliest point to take cash is at the sale itself, before the remaining proceeds go to your qualified intermediary. That amount is boot from the start, and the reinvestment target for full deferral of the rest drops by the same amount.
Funds Held by the Qualified Intermediary
Once the proceeds sit with the intermediary, Regulation 1.1031(k)-1(g)(6) gives you the qualified intermediary safe harbor only if your exchange agreement bars you from receiving, pledging, or borrowing against them until the exchange period ends, with a few listed exceptions.
- ●Nothing identified: if you identify no replacement property, the funds can be released any time after the 45-day identification period.
- ●Everything received: once you have received all the replacement property you are entitled to under the agreement, leftover cash can be paid out.
- ●Written contingency: a material and substantial contingency that relates to the exchange, is spelled out in writing, and is outside your control and the control of any disqualified person can trigger release after the identification period.
Boot Received in the Following Tax Year
The same regulation lets the intermediary’s receipt of sale proceeds be disregarded for installment sale purposes when you start the exchange with a bona fide intent to complete it. In Example 2, an owner sells for $100,000 in September, buys an $80,000 replacement the following March, and receives the remaining $20,000 then.
That $20,000 is recognized gain, and subject to the other requirements of sections 453 and 453A, the owner may report it in the later year under the installment method. For a sale late in the year, that rule can shift tax on leftover cash into the following year’s return, although section 453(i) still requires depreciation recapture income to be reported in the year of sale.
How the IRS Taxes Recognized Gain
Once you know how much gain is recognized, the next question is its character, and a property that has been through cost segregation changes the mix.
Section 1245 Recapture on a Cost Segregated Property
Many components a study moves into shorter-lived section 1245 classes remain real property for the exchange, so they qualify as like-kind while carrying their own recapture rules. The Form 8824 instructions apply section 1245(b)(4), which limits recapture to the gain recognized plus the fair market value of non-1245 property you receive.
The instructions show what that means in a partial exchange. In their alternative facts, an owner who received $40,000 of cash reports $50,000 of section 1245 recapture as ordinary income, because the building received counts as non-1245 property and pushes the limit well above the boot; our comparison of section 1245 vs 1250 property covers how each class is recaptured.
Unrecaptured Section 1250 Gain and Capital Gain
Recognized gain that is not ordinary income recapture is reported on Form 4797 for business property or on Schedule D for capital assets, per the Form 8824 instructions. The part tied to depreciation on the building itself is generally unrecaptured section 1250 gain, which IRS Topic 409 caps at a 25% rate.
Our explainer on the depreciation recapture tax rate shows how each layer is taxed when it comes due.
Passive Activity Rules and the Recognized Gain
IRS Publication 925 treats gain from disposing of property used in a passive activity as passive activity income in most cases. Passive losses, including first-year deductions a study produces on a rental replacement property, can generally be used against that income.
A partial exchange generally will not trigger the full release of suspended losses on the old property, since Publication 925 requires disposing of your entire interest to an unrelated person in a transaction where all realized gain or loss is recognized.
How a Partial Exchange Changes Depreciation on the Replacement Property
The exchange rules set your tax on the sale, and the depreciation rules decide how fast you recover the basis that carries into the new building.
Basis in the Replacement Property
Section 1031(d) starts the new property’s basis at the old property’s basis, subtracts money received, and adds gain recognized. Liabilities the other party assumed count as money, and new debt you take on or cash you add will increase basis.
On Form 8824, that total goes on line 25 and is then split between section 1250 property on line 25a and section 1245 property on line 25b in proportion to their fair market values. A cost segregation study breaks the building into components with assigned costs, which gives your CPA documented support for that split.
Exchanged Basis, Excess Basis, and Bonus Depreciation
Regulation 1.168(i)-6 divides the replacement property’s depreciable basis into exchanged basis, carried over from the old property, and excess basis, the amount above it. Excess basis is treated as newly placed in service, while exchanged basis generally continues on the old property’s schedule.
On a used replacement building, Regulation 1.168(k)-2 allows bonus depreciation only on the remaining excess basis, and one of its examples allows none at all when that excess basis is zero. Where the replacement is original-use property, such as a newly built building, both portions of its qualifying components can be eligible.
We see this framing consistently from clients and CPAs after a trade-down: they expect bonus depreciation on the full price of the new building. When the boot is fully taxed, the 1031(d) formula sets the new basis at the old adjusted basis plus any net debt or cash you add, and exchanged basis is capped at the old property’s adjusted depreciable basis, so a different land and building split can also create excess basis. Your CPA should model both before anyone counts on a first-year bonus figure.
The excess basis that does qualify can take 100% bonus depreciation on components acquired and placed in service after January 19, 2025, as our summary of the One Big Beautiful Bill changes explains. An election under Regulation 1.168(i)-6(i) can restart the full basis on new recovery periods, yet bonus on a used building still reaches only the excess basis.
How Seneca Approaches a Study After a Partial Exchange
At Seneca, here is what the cost segregation study process looks like for replacement property acquired in a partial exchange.
Documents We Request From Both Closings
We ask for the settlement statements from the sale and the purchase, the exchange agreement with your intermediary, and the depreciation schedule for the property you sold. Those records let your CPA trace boot, basis, and the exchanged and excess split, and our checklist of documents required for a study lists the rest.
Onsite or Virtual Property Tour
You choose whether our engineers walk the replacement property in person or tour it virtually. Many commercial owners prefer an onsite visit, virtual tours work well for most residential properties, and our page on virtual tours for cost segregation explains how the remote option runs.
A Component Breakdown Your CPA Can Allocate
Our engineers identify every component that makes up the replacement property, from the shorter-life items through the building structure itself, and assign each one a cost and a recovery class. Your CPA can then apply the line 25a and 25b allocation and the exchanged and excess basis rules to real figures, and with timely collaboration from you, we deliver the finished study in 5 to 10 business days.
Mistakes That Cost Owners in a Partial Exchange
Each of these mistakes either creates boot nobody planned for or overstates what the new property will deduct.
- ●Paying non-exchange costs from exchange funds: prorated taxes, rent prorations, security deposits, and repairs are not exchange expenses; review the closing statement with your CPA and your intermediary before funds move.
- ●Buying down in debt without adding cash: a smaller loan on the replacement leaves mortgage boot; take on equal debt or bring in cash to cover the gap.
- ●Counting on new debt or later cash to erase a cash draw: on Form 8824, debt you assume and cash you add can offset debt relief on line 15 but never the cash you receive; decide on any cash draw before the sale closes.
- ●Asking for leftover funds outside the permitted windows: the agreement must restrict access under Regulation 1.1031(k)-1(g)(6); confirm the release terms when you choose an intermediary.
- ●Ignoring recapture on the old building: section 1245 components can produce ordinary income above the boot; review the relinquished property’s depreciation history first.
- ●Modeling bonus on the full replacement price: on a used building, only excess basis qualifies; ask for an estimate that separates the two.
Frequently Asked Questions
Below are the questions we hear most from owners and CPAs working through a partial exchange.
Why Owners Choose Seneca After a Partial Exchange
Seneca does cost segregation and nothing else, and our in-house team handles every study directly, so your CPA talks to the engineers doing the work instead of a sales rep relaying messages. Every report goes through the same internal review, our Head of Engineering signs off before it reaches your CPA, and audit defense is included.
You get a dedicated Project Manager, our Engineering team, and an Advisor, with real-time updates as the study moves through each stage. We also perform Qualified Production Property (QPP) studies, and across 10,200+ properties assessed, from small Midwest single-family homes and short-term rentals to self-storage, manufacturing plants, and 120+ unit hotels, our clients have seen zero IRS audits triggered or lost.
If your replacement property is already under contract, our cost segregation calculator gives you a fast first read.
Conclusion
A partial exchange trades some deferral for flexibility, and the rules that govern it are precise: boot is taxed only up to your gain, debt relief counts as cash, new debt never cancels cash you receive, and your intermediary can release leftover funds only at set points.
For owners whose old building went through cost segregation, the recapture and depreciation rules carry as much weight as the boot itself. The best results come from settling the cash draw, the debt on both sides, and the basis split with your CPA before the sale closes.
When you are ready to plan the study on your replacement property, request a free estimate or run the numbers through our calculator, and our engineers will show you what the new building can deduct.
