Does a 1031 Exchange Carry Over Your Cost Basis? (w/Examples) + FAQs

This article reflects federal rules and selected state rules as of June 2026 and covers tax year 2025 and the 2026 filing season. Tax law changes — confirm current figures before you file. This is educational information, not personalized tax advice. For a real deal with real dollars, work with a CPA, tax attorney, or Qualified Intermediary on your specific facts.

Quick Answer

Yes. A 1031 exchange carries over your cost basis. The replacement property takes a substituted (carryover) basis equal to the adjusted basis of the property you gave up, minus any gain you deferred, plus any extra cash you put in. You do not get a fresh, stepped-up basis.

What This Really Means for Your Tax Bill

When you do a like-kind exchange under Section 1031, the IRS does not let you start over with a clean basis on the new property. Instead, the old property’s adjusted basis follows you into the new one. The gain you skipped paying tax on today is buried inside that lower basis, waiting for the day you finally sell without exchanging again. As the IRS puts it plainly, gain is deferred, but not forgiven, and you must track your basis in the new property.

This matters because a low carryover basis means a bigger taxable gain later, plus the depreciation recapture you thought you escaped. According to a 2025 industry analysis of 1031 timelines, the recaptured depreciation does not disappear in an exchange — it rides along and can be taxed at up to 25% when you cash out. Knowing how basis carries over is the difference between planning your exit and getting surprised by a five- or six-figure bill.

🧮 How to calculate your exact carryover (substituted) basis, step by step with real numbers
💵 Why boot (cash or debt relief) creates a taxable event even inside a “tax-free” exchange
🏚️ How deferred depreciation recapture follows your basis and bites later at 25%
🗺️ Whether your state honors the deferral — and the California and Pennsylvania traps
⚰️ How death and the stepped-up basis can erase the whole deferred gain for your heirs

Deconstructing the Topic: The Five Moving Parts

A 1031 exchange has five concepts that decide your basis. Each one connects to the next, so missing one throws off your whole calculation.

Adjusted Basis

Your adjusted basis is what you have invested in the property for tax purposes. You start with your original purchase price, add the cost of improvements, then subtract the depreciation you have claimed over the years. This is the number that carries over, not the market value.

The consequence of getting this wrong is direct: if you overstate your basis, you understate your future gain and risk an IRS adjustment with penalties and interest. A common misconception is that basis equals what you paid. It does not — years of depreciation deductions have already lowered it. What you should do is pull your depreciation schedule from Form 4562 for every year you owned the property and confirm the running total before you exchange.

Deferred Gain

Deferred gain is the profit you would have paid tax on if you had simply sold. In a fully qualifying exchange, you push all of it forward into the new property by reducing your basis. The gain is not erased; it is parked.

Miss this and you may think you “saved” the tax forever. You did not. The deferred gain reappears the moment you sell the replacement property in a taxable deal. Track the exact deferred amount from Form 8824 and keep that return forever, because you will need it decades later.

Substituted (Carryover) Basis

This is the heart of the answer. Your new property’s starting basis equals its purchase price minus the gain you deferred, as confirmed by the Form 8824 Line 25 instructions. A 1031 calculator from June 2026 explains the same rule: the replacement takes a substituted basis equal to its cost minus the deferred gain.

The consequence is a permanently lower basis on a more expensive building. People wrongly assume the new, pricier property gives them a big new basis to depreciate. It does not — most of your depreciable basis carries over from the old property. After the exchange, write down your Line 25 basis and split it into the carryover portion and any excess basis, because they depreciate differently.

Boot

Boot is any value you receive that is not like-kind property — usually cash you pocket or debt that gets wiped off your books. Per a 2026 real estate CPA guide, boot is taxable in the year of the exchange.

If you take boot, you trigger recognized gain up to the amount of boot received, and your “tax-free” exchange becomes partly taxable. Many investors think touching any cash blows up the whole deal — it does not, it just creates a partial taxable event. To avoid surprise boot, reinvest all net proceeds and replace all the debt on the property you sold.

Depreciation Recapture

Depreciation recapture is the IRS clawing back the tax benefit of the deductions you took. In a clean exchange it is deferred along with the gain. But under the stacking rule, any boot you receive is first applied to recapture at up to 25% before the lower long-term capital gains rate touches a dollar, as a 2026 forensic breakdown of the boot trap details.

Which Situation Applies to You?

The carryover answer is always “yes,” but the amount depends on your facts. Find your row.

You reinvested everything and took no cash, replaced all debt — full deferral; basis carries over cleanly with no current tax.
You pulled out cash or bought a cheaper property — partial exchange; you have boot and owe tax now, with recapture stacked first.
You added section 1245 personal property value (rare post-2018) — possible ordinary recapture even with no boot, per a Mondaq depreciation recapture analysis.
Your relinquished property is in California, replacement is out of state — you must file FTB Form 3840 to track the clawback.
You plan to hold until death — heirs may get a stepped-up basis that erases the deferred gain entirely.

The Carryover Basis Formula (Plain English)

The cleanest way to compute the new basis is the cost approach. You take the purchase price of the replacement property and subtract the gain you deferred.

Replacement basis = Replacement purchase price − Deferred gain.

A second, equivalent way is the transferred-basis approach used on Form 8824: you start with the adjusted basis of the property you gave up, add any cash you paid in and any boot you recognized as gain, and subtract any cash or debt relief you received. Both roads lead to the same Line 25 number, which the 1031.us basis worksheet confirms is your starting basis for the new property.

If you buy more than one replacement property, you split the total basis across them by the ratio of each property’s fair market value to the total cost, again per the 1031.us worksheet.

Worked Example 1: A Fully Deferred Exchange

Maria owns a rental duplex. She bought it for $300,000, spent $50,000 on improvements, and claimed $90,000 of depreciation over the years. Her adjusted basis is $300,000 + $50,000 − $90,000 = $260,000.

She sells the duplex for $600,000 and rolls every dollar into a $600,000 replacement fourplex with a Qualified Intermediary holding the cash. Her realized gain is $600,000 − $260,000 = $340,000. Because she took no boot and replaced all her value, she recognizes $0 today and defers the full $340,000.

Her new basis is the replacement price minus the deferred gain: $600,000 − $340,000 = $260,000. Notice it equals her old adjusted basis. The basis carried over completely, and the substituted basis concept from O’Brien CRE describes this exact mechanic: market value of the new property minus the unrecognized gain equals the substitute basis.

Worked Example 2: A Partial Exchange With Cash Boot

James sells a warehouse with a $200,000 adjusted basis for $500,000. He reinvests $450,000 into a replacement building and pockets $50,000 in cash. That $50,000 is boot.

His realized gain is $300,000, but he only recognizes the lesser of his realized gain or his boot — so he recognizes $50,000. He had taken $120,000 of depreciation, so under the stacking rule his $50,000 of recognized gain is taxed first as unrecaptured section 1250 gain at up to 25%, as the boot-trap breakdown explains. That is roughly $12,500 of federal tax, before state tax.

His new basis equals his old basis ($200,000), plus the recognized gain ($50,000), minus the cash he received ($50,000), which equals $200,000. The remaining $250,000 of deferred gain stays buried in that basis for the next sale.

Worked Example 3: Carryover Erased at Death

Robert exchanged his way up over 25 years and now holds an apartment building worth $2,000,000 with a carryover basis of just $400,000 — meaning $1,600,000 of deferred gain. If he sold today, the tax would be brutal.

Instead, Robert holds the property until he dies. His heirs inherit it at its fair market value of $2,000,000 — a stepped-up basis. As Security 1st Exchange explains, death wipes out the deferred capital gains. The heirs can sell the next day for $2,000,000 and owe essentially nothing, because the step-up eliminates the deferred gain. This “swap till you drop” strategy is the one legal way the carryover basis disappears.

Three Common Scenarios

Scenario A — You reinvest everything

What You Do	What Happens to Your Basis and Tax
Sell for $600K, buy $600K, take no cash, replace all debt	Full deferral; new basis = old adjusted basis; $0 tax now
Keep the same loan amount or larger	No mortgage boot; nothing taxable from debt
Hold and depreciate the new property	Carryover basis depreciates on the old schedule; excess basis on a new schedule

Scenario B — You take cash out

What You Do	What Happens to Your Basis and Tax
Pocket $50K at closing	$50K is cash boot; recognized gain up to $50K, taxed now
Had heavy depreciation	Recapture stacks first at up to 25% before capital gains rates
Want liquidity safely	Wait and do a cash-out refinance after the exchange seasons

Scenario C — You buy down (cheaper property)

What You Do	What Happens to Your Basis and Tax
Sell $500K property, buy $400K property	$100K mortgage/value shortfall becomes boot
Drop your mortgage from $300K to $200K	$100K debt relief is mortgage boot, taxable now
Try to offset cash boot by adding debt	Not allowed; you can add cash to offset debt, not the reverse

Federal vs. State: Does Your State Carry Over the Same Way?

Federal law defers your gain and carries over your basis nationwide. But states do not automatically follow, and two states deserve special attention.

Issue	Federal	State Nuance
Gain deferral	Deferred under IRC §1031	Most states conform; confirm yours
California out-of-state swap	Deferred federally	Must file FTB Form 3840 yearly; clawback applies
Pennsylvania (pre-2023)	Deferred federally	Was taxable immediately before 2023
Pennsylvania (2023+)	Deferred federally	Now conforms under Act 53

California’s Clawback and FTB Form 3840

California honors the federal deferral, but it wants its tax someday. If you sell a California property and buy a replacement outside California, you must file FTB Form 3840 in the exchange year and every year after until you recognize the gain. The form preserves California’s right to clawback the deferred gain even after the property leaves the state.

The consequence of skipping it is steep: the California FTB treats missing 3840 as a top audit issue, and failure to file lets the FTB estimate and assess the deferred gain. You do not need Form 3840 if your replacement property is inside California, per CPEC1031’s reporting guide. File it on time, every year, until the property is finally sold.

Pennsylvania: The Last State to Join

For decades Pennsylvania refused to recognize 1031 deferral for personal income tax, so the gain was fully taxable in the year of the exchange. That changed effective January 1, 2023, under Act 53 of 2022, making Pennsylvania the final state to allow the deferral.

The trap is timing: the change is not retroactive. The Pennsylvania Supreme Court’s Pearlstein decision confirmed that exchanges completed before 2022 remain taxable in Pennsylvania, with penalties and interest. If you exchanged Pennsylvania property before 2023, confirm your state treatment because the old rule still applies to those years.

How Carryover Basis Splits for Depreciation

After the exchange, your Line 25 basis breaks into two pieces, and each depreciates differently. The carryover basis (the old adjusted basis) keeps running on the relinquished property’s existing schedule and remaining recovery period. Any excess basis — the extra cash you paid above the old property’s value — starts a fresh depreciation schedule as if newly placed in service.

You can also elect to treat the entire net tax basis as placed in service on the acquisition date, a choice KBKG describes for cost segregation that can speed up deductions when paired with a study. You report depreciation on Form 4562, and choosing the right method affects your write-offs for years.

Reporting on Form 8824: The Basis Walkthrough

You report every like-kind exchange on IRS Form 8824, filed with your federal return for the year the exchange closed. The form walks you through realized gain, recognized gain, and finally your new basis.

Line 15 captures the boot you received, which drives your recognized gain on Line 20. Line 25 is the payoff line: it computes your basis in the replacement property by subtracting Line 15 from the sum of your other basis inputs, and the Form 8824 instructions confirm Line 25 is your basis in the new property. A step-by-step Form 8824 guide notes you record the aggregate basis for all like-kind assets on Line 25 — keep this number forever.

Deadlines, Costs, and Timing

The two hard deadlines control everything. You have 45 days from closing on the sale to identify replacement property in writing, and 180 days to close on it. Per Pennsylvania’s summary of the federal limits, these cannot be extended for hardship except in a presidentially declared disaster, and missing either one makes the entire gain taxable.

A Qualified Intermediary typically charges a few hundred to about $1,500 per exchange, far less than the tax at stake. Form 8824 can be self-prepared, but a CPA’s fee for a clean exchange is usually modest compared with a five-figure mistake on basis or boot.

Mistakes to Avoid

Treating the new purchase price as your full new basis — you ignore the carryover and overstate depreciation, inviting an IRS adjustment with penalties.
Forgetting deferred depreciation recapture — it follows your basis and hits at up to 25% when you finally sell.
Taking cash at closing without planning — that boot is taxable now, often at the higher recapture rate first.
Buying a cheaper property or smaller loan — the shortfall is mortgage boot and triggers tax you did not expect.
Skipping California FTB Form 3840 — the FTB can estimate your gain and assess tax plus penalties.
Assuming Pennsylvania always deferred — pre-2023 exchanges are still taxable there, with interest.
Losing your old Form 8824 — without it you cannot prove basis decades later and may overpay tax.
Trying to offset cash boot by adding new debt — the rules allow cash to offset debt, not the reverse.

Do’s and Don’ts

Do reinvest all net proceeds and replace all debt, because any shortfall becomes taxable boot.
Do keep every Form 8824 and depreciation schedule forever, because basis tracking spans decades.
Do file California Form 3840 yearly when required, because the clawback right outlives the move.
Do confirm your state’s conformity, because deferral is not automatic at the state level.
Do consider holding until death, because the step-up can erase the deferred gain for heirs.
Don’t touch the sale cash directly, because that breaks the exchange and creates boot.
Don’t assume recapture vanished, because it only deferred and stacks first when boot appears.
Don’t miss the 45- or 180-day clock, because the full gain becomes taxable immediately.
Don’t depreciate the whole new price fresh, because most basis carries over on the old schedule.
Don’t skip a Qualified Intermediary, because self-holding the funds disqualifies the exchange.

Pros and Cons of Carryover Basis

Pro: You defer tax and keep more capital working, because the gain is parked, not paid.
Pro: Depreciation deductions continue, because the carryover basis still depreciates.
Pro: Heirs may get a step-up, because death can erase the entire deferred gain.
Pro: You can compound into bigger assets, because untaxed equity rolls forward.
Pro: Recapture is postponed, because a clean exchange defers section 1250 gain too.
Con: Lower basis means a bigger future gain, because the deferred gain is buried inside it.
Con: Smaller depreciation than a fresh purchase, because most basis carries over old and partly used.
Con: Recordkeeping is heavy, because you track basis across many years and properties.
Con: Boot can surprise you, because cash or debt relief is taxable now.
Con: State rules vary, because conformity and clawbacks add cost and paperwork.

What to Do Next

Pull your adjusted basis: original cost, plus improvements, minus all depreciation from your Form 4562 history.
Hire a Qualified Intermediary before you close the sale, because you cannot touch the proceeds.
Calendar the 45-day identification and 180-day closing deadlines the day your sale closes.
Reinvest all proceeds and replace all debt to avoid boot, or plan for the tax if you take cash.
File Form 8824 with your return and record your Line 25 basis permanently.
If California property left the state, file FTB Form 3840 and keep filing it yearly.
Call a CPA or tax attorney if you have boot, multiple properties, section 1245 assets, or an estate plan in play.

FAQs

Does a 1031 exchange carry over your cost basis? Yes. For tax year 2025, the replacement property takes a substituted basis equal to the relinquished property’s adjusted basis, minus gain deferred, plus any new cash invested. You do not receive a fresh, full basis on the new property.

How do I calculate my new basis after a 1031 exchange? Replacement price minus deferred gain. Take what you paid for the new property and subtract the gain you deferred. The result is your Line 25 basis on Form 8824, the same number you carry forward for depreciation and the next sale.

Is depreciation recapture deferred in a 1031 exchange? Yes. In a clean exchange with no boot, recapture defers along with the capital gain. But if you take boot, that recognized gain is taxed first as unrecaptured section 1250 gain at up to 25% under the stacking rule.

What is boot in a 1031 exchange? Cash or debt relief you receive. Boot is any non-like-kind value, such as cash pocketed or a mortgage reduced. It is taxable in the year of the exchange, up to the amount of your realized gain.

Does taking some cash ruin the whole exchange? No. Taking cash creates a partial exchange, not a full disqualification. You recognize gain only up to the boot received and still defer the rest, while the replacement basis adjusts accordingly.

Will my heirs owe the deferred tax? No, usually not. At your death, heirs generally receive a stepped-up basis to fair market value, which wipes out the deferred capital gain. They can sell near that value with little or no tax.

Does my state follow the federal 1031 deferral? Most do, but not all the same way. Confirm your state. California requires Form 3840 and a clawback, and Pennsylvania only began conforming on January 1, 2023, leaving pre-2023 exchanges taxable.

What form reports a 1031 exchange? IRS Form 8824. You file it with your federal return for the year the exchange closes. Line 25 shows your basis in the replacement property, which you must keep for the life of the asset.

What is the difference between carryover basis and excess basis? Carryover is the old basis; excess is the extra you paid. Carryover basis continues on the old depreciation schedule, while excess basis above the old property’s value starts a new schedule.

Do I need Form 3840 if both properties are in California? No. California’s Form 3840 is required only when the relinquished property is in California and the replacement is out of state, to track the deferred gain that left the state.

How many days do I have to complete a 1031 exchange? 45 days to identify, 180 days to close. Both run from your sale closing. They cannot be extended except for a presidentially declared disaster, and missing either makes the full gain taxable.

Can I do a 1031 exchange on my primary home? No. Section 1031 applies only to real property held for business or investment. A personal residence does not qualify, though it may use the separate home-sale exclusion instead.

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