How deferral works
In a valid 1031 exchange, you don't pay tax on the gain or the depreciation recapture at the time of sale. Instead, the replacement property takes on a carryover (substituted) basis — the relinquished property's adjusted basis, adjusted for any boot. That low basis means the deferred recapture is embedded in the replacement property.
The recapture follows you
When you eventually sell the replacement property without another 1031, all the deferred recapture — including from prior exchanges in a chain — becomes due. The accumulated depreciation from all properties in the chain increases the Section 1250 gain on final sale.
And depreciation restarts
On the replacement property, you depreciate using the carryover basis (which is already reduced by the prior depreciation). Your annual deduction on the building starts from a lower number, reflecting all the prior write-offs.
Frequently asked questions
Does a 1031 exchange eliminate depreciation recapture?
No — it defers it. The deferred recapture is embedded in the replacement property's lower carryover basis and becomes taxable on the eventual non-exchanged sale.
Can you chain 1031 exchanges to keep deferring recapture?
Yes. Each successive exchange continues to defer the accumulated recapture — until you sell outside a 1031 or die (when heirs may receive a stepped-up basis).
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS — Like-Kind Exchanges (Real Estate Tax Tips)
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.