A 1031 Exchange Example With Real Numbers

The relinquished property

Original purchase: $250,000 (land $50,000, building $200,000). Capital improvements: $25,000. Depreciation claimed over 15 years: $200,000 / 27.5 = $7,273/year x 15 years = $109,090. Adjusted basis: $250,000 + $25,000 - $109,090 = $165,910. Net sale price: $550,000. Total deferred gain: $550,000 - $165,910 = $384,090 (recapture: $109,090; capital gain: $275,000).

The replacement property and new basis

You acquire a replacement property for $700,000 (land $140,000, building $560,000). Your carryover basis in the replacement = $700,000 - $384,090 (deferred gain) = $315,910. Depreciable basis = $315,910 - $140,000 (land) = $175,910. Annual depreciation going forward: $175,910 / 27.5 = $6,397/year — significantly lower than the $20,364/year you would get on full purchase-price basis ($560,000 / 27.5).

The tax deferred and the trade-off

By exchanging, you deferred approximately $27,273 in recapture tax (at 25%) and $41,250 in capital gains tax (at 15%) — roughly $68,523 in federal tax kept working in your portfolio. The cost: lower annual depreciation on the replacement property. Whether the compounded investment return on $68,523 over the hold period exceeds the foregone depreciation deductions is the key calculation — in most scenarios with long holds, the exchange wins significantly.

Frequently asked questions

Does a 1031 exchange reset my depreciation deduction?

No. Your depreciable basis is reduced by the deferred gain, producing lower annual deductions than buying without an exchange. However, you also kept the deferred tax working for you.

What is carryover basis in a 1031 exchange?

The replacement property's purchase price reduced by the deferred gain from the exchange. It becomes your tax basis going forward.

Sources

Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.