One of the most common myths about a 1031 Exchange is that once you decide to exchange, you are somehow prohibited from taking any money from the sale of your relinquished property.
That is simply not true.
You are allowed to take proceeds.
You are allowed to keep some cash or reduce the amount of debt that must be replaced.
You are allowed to structure what is called a “partial exchange”.
What you are not allowed to do is take “constructive receipt” of the proceeds and still expect full tax deferral on the money you kept.
That is the distinction too many investors miss.
A 1031 Exchange is not a prison sentence for your equity. It is a tax-deferral strategy. And like most strategies, it can be used in more than one way.
Taking Proceeds Does Not Kill the Exchange
The myth sounds like this:
“If I take any cash out, I can’t do a 1031 Exchange.”
Wrong.
Taking proceeds does not automatically disqualify the exchange. It does not make the entire transaction fail. It does not mean you lose the ability to defer taxes on the portion you do reinvest.
It simply means the proceeds you keep may become taxable.
That taxable portion is commonly called boot.
So if you sell an investment property, complete a properly structured 1031 Exchange, and decide to keep some cash at closing, you may still defer tax on the portion you reinvest while paying tax on the portion you retain.
That is called a partial 1031 Exchange.
The Real Rule Is About Full Deferral
The confusion usually comes from people mixing up two very different ideas:
Allowed and fully tax deferred.
If your goal is to fully defer all capital gains taxes, then yes, you generally need to reinvest all net proceeds, buy replacement property of equal or greater value, and replace the value of any debt paid off.
But that is the rule for full deferral.
It is not a rule that says you are forbidden from taking money out or only replacing a portion of the debt that was paid off upon the sale of the relinquished property.
That difference matters.
Example: How a Partial 1031 Exchange Works
Let’s say you sell a property for $2,000,000.
After commission and closing costs on a sale where you owned the asset free and clear, you have approximately $1,895,000 in net proceeds.
You find a replacement property at $1,750,000.
You did not “blow” the exchange.
You did not ruin the entire transaction.
You simply created a taxable event on the $250,000 difference, while still potentially deferring taxes on the portion you reinvested.
That can be a very smart strategy when planned correctly.
Example: How a Partial 1031 Exchange Works – PT 2
This time let’s say you sell a property for $3,500,000 that has $1,000,000 in debt.
At the close of escrow, approximately $2,200,000 is sent to the accommodator. You find an excellent replacement property at $3,000,000. You obtain a loan of $1,000,000 to satisfy the debt replacement and execute the purchase, leaving $200,000 with the accommodator, which you receive once the exchange is complete.
This is also a partial exchange where you will be taxed on the $200,000 cash you kept.
Why Would Someone Take Proceeds?
Because real life matters.
Some investors want to reduce personal debt. Some want cash reserves. Some want to help family. Some want to pay medical expenses, fund retirement needs, or simply enjoy some of the equity they spent decades building.
And for many long-time property owners, the right answer is not always “exchange every dollar.”
Sometimes the right answer is:
“Let’s defer as much tax as possible while still solving the investor’s real-life financial needs.”
That is where planning becomes powerful.
With that said, there are better ways to get cash after the completion of the exchange that saves you the tax on boot taken.
The Bottom Line
The myth is that you cannot take proceeds from a 1031 Exchange.
The truth is that you can.
You just need to understand the consequence.
Taking proceeds may create taxable boot, but it does not automatically destroy the exchange. It does not prevent you from deferring tax on the portion properly reinvested into qualifying replacement property.
A 1031 Exchange is not all or nothing.
It is a strategy.
And the best strategies are built around the investor’s goals, not someone else’s misunderstanding of the rules.
We Are Here to Help!
If you are an investment property owner, schedule a no-obligation strategy call with me at www.Best1031Online.com, or contact James Bean of SVN-Rich Investment Real Estate Partners, CA DRE# 01970580, at 805-779-1031 or email at james.bean@svn.com.
If you are an agent/broker, I am happy to discuss strategies with you on how to best serve your next listing client in preparing them for a successful exchange. Please visit the site and click on the Agent’s button located at the top right-hand corner of the Home Page!
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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.