The tax a 1031 defers isn't one number, it's four stacked layers: federal capital gains (usually 15–20%), depreciation recapture (up to 25% — the layer long-term landlords underestimate), the 3.8% net investment income tax, and your state's cut (0% to 13%+). On a typical long-held rental, the stack runs 25–35% of the gain. Compute your actual number first — it's the denominator for every other decision in the exchange, including whether to exchange at all.
Sellers reflexively think "15 or 20 percent" and stop. On investment real estate held for years, that's usually the smallest serious layer. The bill is a stack, and until you compute the whole stack, every downstream decision — exchange or sell, DST or direct, take boot or don't — is being made against a fictional denominator.
Applied to your long-term gain (sale price minus selling costs minus your adjusted basis — original price plus improvements minus every dollar of depreciation). Most exchangers with meaningful gains land at 15% or 20% depending on income.
The sleeper. Every year you owned a rental, depreciation reduced your basis whether or not you carefully claimed it (the code assumes "allowed or allowable" — you're recaptured on it either way). At sale, that accumulated depreciation is taxed at up to 25%, ahead of the capital gains layer. On a property held 20+ years, recapture is routinely the largest single line in the stack — and it's the layer that makes "I'll just pay the 15%" a fantasy.
Applies to investment gains once modified AGI clears $200K single / $250K married — thresholds a property sale itself usually vaults you over, since the gain counts toward the test.
From zero (TX, FL, WA and friends) to double digits (California's top rate exceeds 13%, and CA taxes gains as ordinary income). Two wrinkles worth knowing: several states impose withholding at closing on out-of-state sellers, and California operates a claw-back — exchange out of CA property and the state tracks the deferred CA-source gain (via annual filing) to tax it when you eventually sell for cash, wherever you live by then.
Rental purchased for $400,000 two decades ago; $250,000 of depreciation taken; selling today for $950,000 with $60,000 of selling costs. Adjusted basis: $150,000. Total gain: $740,000 — of which $250,000 is recapture and $490,000 is capital gain.
The stack, for a married couple in a 5% state at the 20% bracket: recapture $250,000 × 25% = $62,500; capital gain $490,000 × 20% = $98,000; NIIT $740,000 × 3.8% = $28,120; state $740,000 × 5% = $37,000. Total: ≈ $225,600 — about 30% of the gain — due next April without an exchange. (Illustrative math, not advice; your CPA's version will have more footnotes and better inputs.)
Now you have a denominator. Against $225,600 of deferral: a $1,200 QI fee is 0.5% of the stakes; even a worst-case 12% DST load on the reinvested amount is being weighed against a known number instead of a vibe. And if your stack computes to $18,000? The honest conclusion might be that the exchange isn't worth its constraints. The math is allowed to say no — that's what makes it math.
Deferred is not forgiven — the basis carries forward — so what you're really buying is time and compounding on the government's money: ~$225K staying invested at, say, 6% throws off ~$13,500 a year that a taxed sale wouldn't. Chain exchanges for life and the endgame is the step-up in basis at death, which converts "deferred" into "eliminated" for your heirs — the entire logic of swap-till-you-drop, and of exit structures like the 721 UPREIT.
No — "allowed or allowable" means you're taxed as if you claimed it. If you genuinely didn't, talk to a CPA about a Form 3115 catch-up before selling; it can rescue the deductions you're going to be recaptured on anyway.
A full, boot-free exchange defers the entire stack — recapture, gains, NIIT, and state (subject to state claw-back tracking like California's). A partial exchange defers proportionally; boot is taxed through the same layers, worst rates first.
Your CPA, with your depreciation schedules in hand — ideally before you list. Every serious exchange decision downstream is this number divided by something.
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