Partial 1031 Exchange: When It Makes Sense to Cash Out Equity

A partial 1031 exchange can allow you to defer capital gains tax on part of your sale proceeds while receiving the rest in cash, but any cash boot or taxable boot should be carefully considered before you proceed.

If you’ve already read our 1031 Exchange Guide, then you know the basics of an IRC Section 1031 like-kind exchange, in which capital gains and other taxes on the sale of business or investment real estate can be deferred if the proceeds are used to acquire like-kind property.

When executed properly, a 1031 exchange can allow taxpayers to reinvest more of their sales proceeds into a new, higher-value property or series of properties. If your replacement property is valued higher than your relinquished property (and you preserve your debt ratio), you can defer the related taxes completely.

But that doesn’t mean 1031 is always an all-or-nothing proposition. There are situations where only some of the applicable taxes can be deferred. For example, if you own a property that is used partially for business use and partially for personal use, you can only defer taxes on the portion used for business.

If you want to defer taxes on only some of your sales proceeds and receive the rest in cash, it is possible to do so through a partial 1031 exchange. Also referred to as a partial exchange 1031 strategy, this approach may apply when the 1031 exchange replacement property is valued lower than the relinquished property. It can be useful in some situations, though doing so comes with tax consequences because any cash received may be treated as 1031 exchange boot.

Can you do a partial 1031 exchange and receive cash boot?

1031 exchanges can be considered in three groups: those where the replacement property is worth more than the relinquished property, those where the properties are equal in value, and those where the relinquished property is worth more. The simplest scenario is where the properties are valued at the exact same amount, as this involves no additional capital and full tax deferral. The scenario where the replacement property is worth more can also involve full tax deferral, but requires additional cash and/or debt to make up the difference.

Our focus here is the third scenario, where the relinquished property is worth more. In this case, there would be some leftover sales proceeds, which would be returned to the exchanger in the form of 1031 exchange boot, which is subject to taxation. Why might you want to do this? Perhaps you have your heart set on a certain property that isn’t worth quite as much as the one you’re selling, and you don’t want to add a DST as an additional replacement property. Perhaps the tax environment is ideal right now and you’d rather partially cash out before tax rates go up. Perhaps you want to consolidate from several property holdings into a single property that doesn’t quite equal the ones you’re selling.

Another reason applicable to 2026 is the rate environment. When interest rates are high, acquiring a high-value property can be costly, and in competitive environments, finding the perfect replacement property can be tough. Instead of over-committing to an expensive property at a high rate, settling on a property that doesn’t match the value of your relinquished property, but that you have more confidence in as an investment, could be a wise choice. Whatever the reason, you have the ability to receive some cash but must pay taxes on it.

In a partial 1031 exchange, when do I get the rest of my money?

According to IRC Section 1031, you have 180 days from the date your relinquished property sale closes to complete your exchange. On Day 181, you receive any leftover cash boot from the Qualified Intermediary (QI).

If you own your property outright, the math is pretty straightforward: the sales proceeds are held by the QI, some are used to acquire the replacement property, and the rest are returned to the exchanger. But what if you have a mortgage on your relinquished property? You’ll need to pay off that loan with some of the sales proceeds, and apply for a new loan for your replacement property. And as Certified Exchange Specialist® Nicole Vella explained at a JTC webinar, partial exchanges are limited as to how you can adjust your level of debt as you exchange into a new property, which makes 1031 exchange debt replacement an important planning point.

“You can replace debt with cash, but you cannot replace cash with debt, so you always need to use that equity piece towards the purchase in order to not raise a red flag,” said Vella.

For example, if you sell a property worth $5,000,000 and owe $1,000,000 on your mortgage, the sale would give you $4 million equity after paying off the $1 million debt. You can’t use that $4 million to acquire a $3 million property with a $2 million mortgage and receive a $3 million boot if you want to continue tax deferral. The debt ratio needs to remain the same, so you must have debt equaling 20% of the $3 million, or $600,000, to match the amount owed on the relinquished property. Alternatively, you could pay off the original loan and have no debt on the replacement property. But you can’t extract equity from the investment and still defer taxes.

Unlike an exchange into a higher-value property, partial exchanges limit the amount of tax you can defer. You will have to pay taxes on any cash you receive, and won’t receive the full 1031 benefits that you might have received had you performed an exchange into a property of equal or greater value. This means any taxable boot should be modelled carefully before deciding to cash out of part of the exchange. That’s why if you want to continue investing in real estate and build more wealth over time, an exchange that offers full tax deferral is the most common choice.

How to fully defer capital gains tax in a 1031 exchange

Even if it doesn’t seem realistic to find a single property that offers the value you’re looking for, there are ways to achieve full tax deferral. Multi-property exchanges are allowed, so instead of one high-value property, you could look for a series of properties to match the value of your relinquished property. As mentioned, Delaware Statutory Trusts (DSTs) can be ideal replacement properties to add to an exchange when there is a gap in value. And improvement exchanges allow for some exchange funds to be used to make improvements on a property during the exchange, helping transform a lower-value property into a high-value property.

For any exchange, you will need to work with a Qualified Intermediary that will hold funds during the exchange. While there are plenty of options for who can act as your QI, most won’t have experience with these complicated types of exchanges. If you want to preserve tax deferral while removing cash or exchanging into new property types, work with a QI that has helped exchangers successfully do so time and again.

How to choose the right QI