One of the most common myths I hear online and in social media about 1031 exchanges is that you only need to reinvest the profit—the gain— from the sale of your relinquished property to defer taxes. That’s simply not true, and it’s a misunderstanding that can end up costing you a lot in capital gains taxes if you’re not careful.
Here’s the reality: In a 1031 exchange, you must reinvest the entire net proceeds from the sale of your relinquished property—not just the gain. That includes your original equity and any debt you had on the property. It’s not just the “profit” that counts.
The first rule is clear – “Equal to or Greater Than the Sale Price of the Relinquished Property.”
Let’s break this down so it’s crystal clear.
Reinvesting the Entire Net Proceeds—Not Just the Profit
When you sell an investment property, you walk away from the closing table with a check (or a wire transfer) for the net proceeds, except when you are about to exchange because then your proceeds would go directly to your accommodator (QI) that you engaged prior to closing. This is the sale price minus commissions, closing costs, and any loan payoff. The IRS doesn’t care how much of that is “profit” or “principal” from your original investment. They expect you to roll all of it into a new like-kind property if you want to defer 100% of your capital gains tax.
So, if you sell your property for $3 million, it doesn’t matter if you only made $500,000 in profit. You’ve got to reinvest the full $3 million sale price, less commissions and closing costs, into the replacement property. That’s the only way to fully defer 100% of the capital gains taxes.
What Happens If There’s Existing Debt?
Here’s where the confusion often sets in. If you had an existing loan on the property you sold, that debt payoff has to be replaced in the new property, too. Let’s use a clear example:
Suppose you sell your property for $3 million. At closing, you pay off a $1 million loan, and you have about $1.9 million left over after commissions and closing costs. Many people mistakenly think they only have to reinvest that $1.9 million. That’s not how it works.
To fully defer 100% of the taxes in a 1031 exchange, you have to replace the entire value of the relinquished property—$3 million. That means you either:
✅ Obtain a new loan on the replacement property for $1 million, or
✅ Come out of pocket with $1 million in cash, or
✅ Some combination of the two.
Either way, the replacement property’s purchase price needs to be at least $3 million to avoid having any taxable “boot.”
If you don’t replace that $1 million in debt, the IRS treats that unpaid portion as taxable boot—like you took cash out of the deal. It doesn’t matter that you didn’t physically get the money in your hand; the IRS sees it as a gain to you, and you’ll owe capital gains tax on that amount.
No Debt? No Problem—But Reinvest It All
If you own your relinquished property free and clear, the math is simpler. Suppose you sold your $3 million property with no debt. After commissions and closing costs, you might have around $2.9 million in cash. In that scenario, you don’t have to get a new loan—because you have all the cash you need to buy a $3 million replacement property. You’re still meeting the rule: replacing the total sale price of the relinquished property.
The Big Takeaway
So, let’s put this myth to rest: It’s not enough to just reinvest the profit or gain from your sale. In a 1031 exchange, you must replace the entire sale price—cash and debt combined. If you don’t, the portion you didn’t replace will be taxable boot.
✅ Sell a $3 million property? Replace it with at least a $3 million property.
✅ Have debt on the relinquished property? Replace it with either new debt or new cash.
✅ Want to avoid paying any capital gains taxes now? Roll over every dollar you received and replace the mortgage debt you paid off.
This is why I always emphasize working with a seasoned 1031 exchange advisor who understands the fine points of the law. The difference between “only the profit” and “all proceeds and debt” can mean the difference between thousands—sometimes hundreds of thousands—in taxes due.
If you’re planning an exchange, or if you’re unsure how this applies to your property, let’s talk. My job is to make sure you’re set up for success— and that means making sure you reinvest every dollar, including any debt, so you can keep Uncle Sam from taking a big chunk out of your investment growth.
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If you are an investment property owner who is interested in a no obligation, private consultation, please visit www.Best1031Online.com, or contact James Bean
of SVN-Rich Investment Real Estate Partners, CA DRE# 01970580, at 805-779-1031
or email at [email protected].
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All information is deemed to be accurate and is not tax or legal advice. All investors/taxpayers should consult their CPA, tax attorney and investment advisors.