What tax do I owe when I finally sell a 1031 replacement property for cash?

The deferred gain has no line of its own; it hides in a basis that never grew

Nothing on the return says "gain deferred in 2009." What happened is that each exchange handed the old basis forward, so the property you are selling now is carried far below what you paid for it.

Sale price less selling costs, minus that carried basis, produces one number that contains the whole history. A building bought for $2,000,000 in an exchange with a $1,015,000 carried basis already holds $985,000 of old gain before it appreciates a dollar.

This is the sentence people mean when they call a 1031 a loan from the government. Whether the exchange was ever tax-free in the first place is answered by this page's arithmetic.

Paying off the loan at closing is proceeds, so a break-even sale can still be taxable

Regulations section 1.1001-2(a)(1) puts it beyond argument: the amount realized "includes the amount of liabilities from which the transferor is discharged as a result of the sale or disposition."

Hypothetically: you sold a building for $1,200,000, a $600,000 loan was paid off, your adjusted basis was $250,000, and you placed the $600,000 of equity into a leveraged trust whose share of nonrecourse debt allocated to you was also $600,000. Your basis in that interest starts at $250,000, because the debt you shed and the debt you took on cancel.

Five years later the trust sells for exactly what it paid. You receive your $600,000 back and the lender is repaid. The amount realized is $1,200,000, the basis is $250,000 less five years of depreciation, and the gain is roughly $1,000,000 on a property that made nothing. How a trust's own sale is handled and whether to exchange out of it is the decision that follows.

Depreciation from every property in the chain is taxed at up to 25%

The 25% bracket is not limited to the building you are selling. Section 1250(b)(3) defines depreciation adjustments as all adjustments "reflected in the adjusted basis of such property on account of deductions (whether in respect of the same or other property)."

Because each exchange pushed the earlier property's reduced basis forward, the deductions you took in 2004 and 2013 are reflected in what you are selling in 2026, and §1(h)(6) sweeps them into unrecaptured section 1250 gain.

Two boundaries keep it honest. Unrecaptured section 1250 gain cannot exceed the gain, and it is a maximum rate rather than a flat one, so a low-income year taxes it at your ordinary rate instead. The same rules applied to a single rental sale are worth reading alongside this.

The rates also stack rather than blend. Section 1(h) taxes the layers in order, so the 25% component sits above the ordinary income that filled your brackets and below the 20% layer, which is why a single large sale can push part of the same gain from 15% to 20%.

A $2,600,000 sale at the end of a chain: about $481,000 federal

Hypothetical, round figures, a married couple in the top brackets. The building sells for $2,600,000, selling costs are $156,000, so the amount realized is $2,444,000. The carried basis from the last exchange was $1,015,000 and you have claimed $400,000 of depreciation since, leaving $615,000.

The gain is $1,829,000. Of that, unrecaptured section 1250 gain is the depreciation reflected in the basis: $400,000 on this property plus $520,000 claimed on the two earlier properties, or $920,000, taxed at 25% for $230,000.

The remaining $909,000 at 20% is $181,800, and the 3.8% net investment income tax on $1,829,000 adds $69,502. That is roughly $481,000 before any state tax, on a property whose visible appreciation since the last exchange was $600,000.

• Form 4797 Part III carries the sale and the depreciation figure into the computation.
• The Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions takes the smaller of the depreciation or the total gain.
• Section 1245 property carved out by any cost segregation study is ordinary income first and never reaches the 25% bracket.
• Suspended passive losses from the property are freed on a fully taxable disposition, which can be the largest single offset available.
• State tax follows its own rules, and a few states claw back gain that was earned inside their borders earlier in the chain.

Four ways to not write that cheque, and what each one costs

Exchange again is the simplest, and the only requirement is that you decide before the closing rather than after, because once proceeds reach you the option is gone. An intermediary has to be in place and the assignment signed before title transfers.

A 721 UPREIT contribution converts the property into operating partnership units without recognition, but it ends the 1031 road: units are not real property, so there is no exchange after that.

Holding until death is the only complete erasure. Section 1014(a) gives heirs a basis equal to date-of-death fair market value, which is why the swap-till-you-drop plan is a real plan and not a slogan.

• Split the last property across several trusts so their separate sale dates land the gain in different tax years; that design is worked through in full.
• Take part of the proceeds as deliberate boot and exchange the rest, paying tax on a slice you choose rather than all of it.
• Check whether a low-income year, a large charitable gift or a loss elsewhere makes recognition cheaper than another exchange.
• Get the depreciation history for every property in the chain to your CPA before you sign a listing agreement, and confirm the computation with them or your attorney.