A 1031 Exchange Example

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The Ron and Maggie Story

Consider the case of Ron and Maggie1, a couple who bought a modest apartment complex in California a decade ago for $1,500,000.  They contributed $500,000 of their personal funds and secured the remaining $1,000,000 with a mortgage.

Purchase Price

Cash Equity Paid by Investor $500,000
Mortgage Financing $1,000,000
Purchase Price $1,500,000

Determine Adjusted Basis

Over the course of several years, the adjusted basis of the property owned by Ron and Maggie could resemble the following: 

Purchase Price $1,500,000
PLUS: Acquisition Costs (Example: Title Insurance) $10,000
PLUS: Capital Improvements (Example: New Roof) $65,000
LESS: Depreciation Taken During Ownership $(400,000)
LESS: Deferred Capital Gains $-
EQUALS: Adjusted Tax Basis at Sale $1,175,000

Calculate Realized Gain

Ron and Maggie are contemplating selling their property, which they believe could be sold for $2,850,000.  If they factor $50,000 in closing costs, their “realized gain” may look like this:

Realized Gain

Sales Price of Relinquished Property $2,850,000
LESS: Closing Costs on Relinquished Property $(50,000)
EQUALS: Net Selling Price $2,800,000
LESS: Adjusted Tax Basis (From Step 1) $(1,175,000)
EQUALS: Realized Gain $1,625,000


Keep in mind that the actual gain differs from cash obtained through the sale. Assuming the mortgage has been reduced to $800,000, the net cash received could be represented as follows:

Net Cash Received

Sales Price $2,850,000
LESS: Balance on Mortgage to Pay Off $(800,000)
LESS: Closing Costs on Relinquished Property $(50,000)
EQUALS: Net Cash Received on Sale $2,000,000

Estimate Potential Tax Liability

Next, Ron and Maggie estimate their potential tax liability from the property sale. With an assumed Realized Gain of $1,625,000 (refer to the earlier calculation), the sale is expected to put the couple in the highest tax bracket, and their possible tax liabilities could look like this:

Federal Capital Gains Tax1 20.0% $245,000
Federal Tax on Depreciation Recapture2 25.0% $100,000
Affordable Care Act Surtax 3.8% $61,750
State Capital Gains Tax (CA)3 12.3% $199,875
TAXES DUE (Effective Tax Rate)4 37.3% $606,625

(1) Federal Capital Gains equal to Realized Gain less depreciation taken multiplied by the applicable rate.
(2) Based on amount of depreciation taken during ownership of the property. In this example, the amount is based on $400,000 of depreciation taken.
(3) Rate varies by state. Example assumes California.
(4) Effective tax rate depicted as a percentage of Realized Gain of $1,625,000 (from Step 2).


Keep Your Equity!

Through the use of a 1031 exchange, Ron and Maggie could potentially defer 37.3% in taxes and preserve all of the profit from the sale of their property.  This means they would potentially have more than $600,000 in additional equity to reinvest!

  With 1031 Exchange Without 1031 Exchange
Net Proceeds from Sale $2,000,000 $2,000,000
LESS: Taxes Paid $- $(606,625)
EQUALS: Equity Available to Reinvest $2,000,000 $1,393,375

How Much Time do I Have?

There are two important deadlines; if either are missed, taxes will be owed. The IRS does not grant extensions on these deadlines.  You have 45-days from the date you sell your property to identify potential Replacement Property(ies).  You have 180-days from the date you sell your property to purchase your Replacement Property(ies).

What MUST I Buy?

In order to defer all of your capital gains taxes, the Replacement Property must have a purchase price and mortgage balance equal to or greater than the Relinquished Property being sold. Investors are not required to reinvest 100% of their sales proceeds in replacement property. This is known as a “Partial Exchange” and the portion the exchange proceeds that are not reinvested are referred to as “Boot” and are subject to taxes. 

Ron and Maggie believe their property can be sold for $2,850,000. Assuming the mortgage balance will be $800,000, their evaluation of a suitable Replacement Property would look like this: 

Replacement Property   Relinquished Property
Purchase Price $3,975,000 > OR = Sale Price: $2,850,000
LESS: New Mortgage: 2,000,000 > OR = LESS: Mortgage Bal.: 800,000
ADD: Closing Costs** 25,000   LESS: Closing Costs: 50,000
EQUALS: Proceeds $2,000,000 > OR = EQUALS: Proceeds: $2,000,000

Closing Costs are considered part of your equity

What MAY I Buy?

In general, any type of real estate investment property type may qualify for an exchange, except your primary residence. The IRS considers all “Investment Properties” to be “Like-Kind.”

  • Properties do not need to be the same type. For example, raw land can be exchanged for an office building, a warehouse can be exchanged for NNN retail property, or a rental house for a Replacement Property Interest in a 300-unit apartment complex.
  • Properties can be located anywhere in the US. For example, a property in California can be exchanged for one in Texas.
  • An exchange can be multiple properties. For example, you may sell one property and exchange into three and vice versa.


1. Ron and Maggie are a fictitious couple used here and in our 1031 Ebook.

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