Can I Cash Out When I 1031 Exchange

I hear clients ask this all the time.

The 1031 Exchange

The client is selling an investment property and structuring a 1031 exchange so that they can defer the payment of their capital gain and depreciation recapture income taxes into another property they intend to acquire through the 1031 exchange.

Cashing Out or Having Your Cake and Eating it Too

But, they would like to pull some cash out of the transaction when the sale of their current investment property closes. The frustrating part is that clients get so many conflicting messages that they are not sure who or what to believe.

The Answer: It Depends

Those who know me and/or my real estate blogs know that my favorite answer is "It depends." In this case, it depends on whether the client wants to defer the payment of all of their income taxes or just some. The client must reinvest 100% of his or her net cash proceeds from the sale of the investment property in order to defer all of their capital gain and depreciation recapture taxes.

Cash Boot

The cash they pull out will be considered "cash boot" and will be taxable. The fact that they are pulling some of the cash out of the sale will not jeopardize their 1031 exchange transaction (contrary to what some tax advisors will say), but it will result in the payment of some taxes.

Don't Pull Too Much Cash Out

It is also important to make sure that the amount that is pulled out does not result in the recognition of all the client's income taxes. It is possible to pull too much out so that the 1031 exchange will actually not defer any taxes. This is a relatively easy computation that you tax advisor can make for you.