Can I Do a Partial 1031 Exchange?

Yes. You don't have to reinvest every dollar to do a 1031 exchange. In a partial exchange, you keep some of the proceeds, or buy a less expensive property, and pay tax on that portion while deferring the rest.

How a partial exchange works

Anything you receive in an exchange that isn't like-kind property is called boot, and it's taxable. In a partial exchange, boot usually comes from one of three places:

• Cash you keep from the sale proceeds

• Buying down, where your replacement property costs less than what you sold

• Reduced debt, where your new loan is smaller than the one you paid off and you don't make up the difference with cash

The rest of your gain stays deferred, as long as you buy qualifying replacement property within the 45 and 180-day deadlines.

How the boot is taxed

You're taxed on the boot up to the amount of your total gain. It doesn't increase your tax beyond what a full sale would have cost.

One detail that surprises people: the taxable portion is typically applied to depreciation recapture first, which is taxed at a higher federal rate than long-term capital gain. Your CPA can tell you what the boot will cost before you decide how much to keep.

Decide before your sale closes

The cleanest way to keep cash is to take it at the closing of your sale, before the rest of the proceeds go to your QI. That portion is taxable, and the rest goes into the exchange.

Once the funds are with your QI, the exchange rules generally don't allow you to take money out until the exchange is over. Depending on your situation, that may not be until after your purchase closes, or until day 180. So if you want cash, plan for it up front.

It's also possible to receive leftover funds after you close on your replacement property, once the exchange is complete. Those funds are taxable as boot.

When a partial exchange makes sense

Investors use partial exchanges when they want some cash for another purpose, when they find a replacement property they like that costs less than what they sold, or when they want to pay down debt. Deferring most of the gain is often still well worth it, even if you don't defer all of it.

Talk through the numbers

Before you go under contract on your replacement property, have your CPA run the numbers on a full versus partial exchange. Then let us know your plan so we can coordinate the funds with your closing agent.

APX 1031 is a Qualified Intermediary. We don't provide tax or legal advice; talk with your CPA or attorney about your situation.