How to Calculate the Exact Tax Savings From a 1031 Exchange

What a 1031 Exchange Actually Defers

Section 1031 of the Internal Revenue Code allows an investor to sell an investment property and reinvest the proceeds into a like-kind replacement property without recognizing taxable gain at the time of sale. The tax is not forgiven. It is deferred indefinitely, or until the replacement property is sold outside of another exchange.

The deferral applies to two distinct taxes. Most investors know about the first. Many underestimate or ignore the second.

Capital gains tax. Long-term capital gains on real property are taxed at 0%, 15%, or 20% depending on taxable income. High earners also pay the 3.8% Net Investment Income Tax (NIIT), bringing the effective maximum to 23.8%.

Depreciation recapture tax. The IRS taxes the portion of your gain attributable to depreciation deductions at 25%. This is called Section 1250 unrecaptured gain. It is separate from, and in addition to, the capital gains rate applied to the appreciation above your original purchase price.

Understanding the interaction between these two taxes is the only way to calculate your actual savings.

The Three Numbers You Must Calculate First

Before you can model savings, you need three figures.

1. Adjusted Cost Basis

Your adjusted basis is not what you paid for the property. It is what you paid, plus capital improvements, minus accumulated depreciation.

Adjusted Basis = Purchase Price + Capital Improvements - Accumulated Depreciation

Depreciation on residential rental property runs at 1/27.5 of the depreciable building value per year. On commercial property, the figure is 1/39. Land is not depreciable.

A property purchased for $500,000 with $100,000 allocated to land and $400,000 to improvements, held for 10 years as residential rental, accumulates $145,454 in depreciation ($400,000 / 27.5 x 10). The adjusted basis is $354,546.

2. Net Sale Proceeds

Net proceeds equals the contract sale price minus selling costs. Selling costs typically include agent commissions (4% to 6%), title fees, transfer taxes, and closing costs. On a $900,000 sale, assume $54,000 in costs (6%). Net proceeds equal $846,000.

3. Total Realized Gain

Realized Gain = Net Sale Proceeds - Adjusted Basis

Using the figures above: $846,000 - $354,546 = $491,454 total realized gain.

That $491,454 is not taxed at a single rate. It splits into two buckets.

Splitting the Gain: Capital Appreciation vs. Depreciation Recapture

The $145,454 of accumulated depreciation is taxed at 25% under Section 1250 recapture rules. The remaining $345,999 of appreciation is taxed at the long-term capital gains rate applicable to the investor's income level.

For an investor in the top bracket, the math looks like this:

| Component | Amount | Rate | Tax Owed | |---|---|---|---| | Depreciation Recapture | $145,454 | 25% | $36,364 | | Long-Term Capital Gain | $345,999 | 20% | $69,200 | | Net Investment Income Tax | $491,454 | 3.8% | $18,675 | | Total Tax Due | | | $124,239 |

A 1031 exchange defers all $124,239. That is the actual savings figure, not a rough estimate based on one rate applied to one gain number.

Worked Example 1: Residential Rental Property

An investor bought a single-family rental in 2014 for $380,000. The land was appraised at $80,000. The building basis of $300,000 has been depreciated over 11 years. Accumulated depreciation equals $120,000 ($300,000 / 27.5 x 11). Capital improvements totaled $25,000.

Adjusted basis: $380,000 + $25,000 - $120,000 = $285,000

The investor sells in 2026 for $780,000. Selling costs of $46,800 (6%) apply.

Net proceeds: $733,200

Total realized gain: $733,200 - $285,000 = $448,200

Gain split:

• Depreciation recapture: $120,000 at 25% = $30,000
• Capital appreciation: $328,200 at 20% = $65,640
• NIIT on full gain: $448,200 x 3.8% = $17,032

Total deferred tax from 1031 exchange: $112,672

Without the exchange, the investor owes $112,672 in the year of sale. With the exchange, that liability carries forward into the replacement property's basis.

Worked Example 2: Commercial Property Held 20 Years

A commercial warehouse was purchased in 2005 for $1,200,000. Land value was $200,000. Building basis of $1,000,000 has depreciated over 20 years at the commercial rate of 1/39. Accumulated depreciation equals $512,821 ($1,000,000 / 39 x 20). No capital improvements were made.

Adjusted basis: $1,200,000 - $512,821 = $687,179

The investor receives an offer of $2,400,000. Selling costs of $120,000 apply.

Net proceeds: $2,280,000

Total realized gain: $2,280,000 - $687,179 = $1,592,821

Gain split:

• Depreciation recapture: $512,821 at 25% = $128,205
• Capital appreciation: $1,080,000 at 20% = $216,000
• NIIT on full gain: $1,592,821 x 3.8% = $60,527

Total deferred tax from 1031 exchange: $404,732

This is where the scale of a 1031 exchange becomes concrete. Over $400,000 remains invested in the replacement property instead of being paid to the IRS. At a 6% annual return on the replacement property, that $404,732 generates $24,284 per year in additional income, compounding forward until the next event.

Boot: What Reduces the Tax Deferral

Not every 1031 exchange defers 100% of the tax. If the investor receives cash or other non-like-kind property in the transaction, that amount is called "boot" and is taxable immediately.

Common sources of boot:

• Cash received at closing because the replacement property costs less than the relinquished property's net proceeds.
• Mortgage relief when the replacement property carries a smaller loan than the relinquished property.
• Personal property included in the sale.

Boot is taxed at the same rate structure described above. If $50,000 of boot is received on the warehouse transaction in Example 2, the investor owes tax on that $50,000 in the year of sale, prorated against the gain.

To maximize deferral, the replacement property must be of equal or greater value, and the equity reinvested must equal or exceed the net equity from the sale.

The 45-Day and 180-Day Rules Affect Your Math

The IRS imposes strict time limits that affect deal structure and, indirectly, the economics of the exchange.

45 days. After closing on the relinquished property, the investor has 45 calendar days to identify up to three potential replacement properties (or more under the 200% rule and 95% rule exceptions).

180 days. The investor must close on the replacement property within 180 calendar days of selling the relinquished property, or by the tax return due date for that year (whichever is earlier).

Missing either deadline triggers full recognition of the gain. On the warehouse example above, a missed deadline costs $404,732 in immediate tax. Calendar management is not a procedural formality.

Basis Carry-Forward: The Long-Term Calculation

The deferred gain does not disappear. It reduces the basis of the replacement property. This matters for every future calculation.

In Example 1, the investor deferred $448,200 of gain. If the replacement property costs $900,000, the adjusted basis for that property starts at $900,000 minus the deferred gain ($448,200), equaling $451,800. Future depreciation, future gain calculations, and future exchange savings all flow from that lower starting basis.

Investors who plan to exchange repeatedly through multiple property cycles can defer the original gain indefinitely across a portfolio. Upon death, the heir receives a stepped-up basis under current law, potentially eliminating the deferred tax entirely.

Run Your Own Numbers

The variables in a 1031 exchange calculation change materially based on holding period, property type, income level, state tax rates, and deal structure. A single percentage-point difference in the capital gains rate shifts the outcome by thousands of dollars.

The CalcMoney income tax calculator lets you input your specific gain components, depreciation figures, and filing status to generate a precise deferred liability estimate. Run the numbers before committing to a sale price or replacement property budget.

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The exchange only works if the reinvestment math works. Start with the tax figure. Build the deal around it.