1031 Exchange Cost Basis: Formula, Boot, and Form 8824

The cost basis of the replacement property in a 1031 exchange equals the adjusted basis of the property you gave up, minus any cash or debt relief you received, plus any gain you were required to recognize.¹ That single number sets your depreciation schedule for the new property, determines how much deferred gain the IRS will eventually collect, and lands directly on line 25 of Form 8824 when you file.² Get it wrong and the mistake follows you until the property is sold, sometimes years later.

Step One: Find the Adjusted Basis of the Property You Gave Up

The calculation starts with the adjusted basis of the relinquished property. Begin with the original purchase price plus acquisition costs such as legal fees, title insurance, and surveys.³ Then run two adjustments across the years you owned it.

Capital improvements increase basis. A new roof, an added unit, or a major renovation that extends useful life gets added to cost. Routine repairs and maintenance do not.

Depreciation decreases basis. Every year you hold investment real estate, the IRS reduces your basis by the depreciation allowed or allowable, whether or not you actually claimed the deduction.³ Forgetting to deduct it doesn’t preserve your basis.

A quick illustration: you buy a rental for $500,000, add $50,000 in improvements, and claim $100,000 in depreciation. Adjusted basis is $450,000. That’s the number that carries into the exchange.

Step Two: Apply the Formula

The statute states it directly. Basis of the replacement property equals the basis of the property exchanged, decreased by money received, and increased by any gain recognized.¹ In plain terms:

New basis = old adjusted basis − cash received + gain recognized

An equivalent shortcut some investors prefer: the cost of the replacement property minus the deferred gain. Both roads produce the same number, and the Form 8824 instructions walk the calculation line by line to line 25.⁴

A Clean Exchange With No Boot

Your relinquished property has a $450,000 adjusted basis and sells for $1,000,000. Realized gain is $550,000. You roll the full amount into a $1,000,000 replacement, take no cash, and don’t reduce debt. The entire $550,000 gain is deferred, and your new basis is simply $450,000.¹

The math checks. Sell the replacement the next day for $1,000,000 and you’d recognize $550,000 in gain, exactly what you deferred. The lower basis is how the IRS keeps score.

Trading Up With Additional Cash

Extra cash you put into a more expensive replacement property increases your basis. Same $450,000 old basis, same $1,000,000 sale, but you buy a replacement for $1,200,000 by adding $200,000 out of pocket. No boot received, so the full $550,000 gain is deferred. New basis: $450,000 carried over plus the $200,000 in new cash, or $650,000.

The alternative formula confirms it: $1,200,000 cost minus $550,000 deferred gain equals $650,000. That higher basis is a bigger depreciable amount, which is a large part of why investors trade up.

How Boot Changes the Number

Boot is anything you receive in the exchange that isn’t like-kind real property. The two common flavors are cash you pocket and debt relief. Boot forces you to recognize gain immediately, up to the amount of boot received, and it reshapes the basis math.¹

Cash Boot

Relinquished property with a $450,000 adjusted basis sells for $1,000,000, and you buy a replacement for $900,000. The $100,000 you didn’t reinvest comes back to you as cash boot. Realized gain is still $550,000, but you must recognize $100,000 of it now because that’s how much boot you received.¹

Now the formula. New basis = $450,000 old basis − $100,000 cash received + $100,000 gain recognized = $450,000. The deferred gain embedded in the replacement is $450,000 ($900,000 cost minus $450,000 basis). Add the $100,000 recognized now and you’re back to $550,000 total.

Mortgage Boot

Debt relief is treated the same as cash. If the other side assumes your $400,000 mortgage and you take on only a $300,000 mortgage on the replacement, that $100,000 net debt reduction is money received.¹ To defer all the gain, replacement debt needs to be at least as high as the debt relieved on the old property, or you must make up the shortfall with additional cash at closing.

Boot You Pay

Paying boot cuts the other way. Extra cash contributed or a larger mortgage assumed on the replacement produces no recognized gain. The additional investment just adds to your basis, and you get more to depreciate.

Exchange Expenses Reduce the Boot You Recognize

Transaction costs necessary to complete the exchange, such as real estate commissions, qualified intermediary fees, title insurance, and closing attorney fees, reduce the boot you’re treated as having received. The Form 8824 instructions direct you to subtract exchange expenses from boot received.⁴ Less boot means less recognized gain, and it moves your final basis accordingly.

Not every closing cost qualifies. Loan origination fees, prorated property taxes, and prorated rent are not exchange expenses. Paying those items out of exchange proceeds can cause the IRS to treat those amounts as cash boot to you. Safer to pay all loan-related and non-exchange costs with personal funds outside the exchange escrow.

Splitting Basis Among Multiple Replacement Properties

If you acquire more than one replacement property, the carried-over basis is split among them in proportion to their fair market values. Treasury Regulations require the proportional allocation; you cannot load the basis onto whichever property you prefer.

Defer $400,000 of gain and acquire two properties worth $600,000 and $400,000, and the first takes 60% of the exchanged basis while the second takes 40%. Any excess basis from added cash allocates the same way. An error here distorts depreciation on each property for as long as you own them.

Exchanged Basis and Excess Basis: The Split That Drives Depreciation

For depreciation, the replacement property’s basis has to be broken into two pieces, and this is where many investors and even some accountants stumble.

The exchanged basis is the portion equal to the adjusted basis of the old property. It keeps the same depreciation method and remaining recovery period. Twelve years left on a 27.5-year schedule means twelve years left, on the same schedule, in the new property.

The excess basis is anything above the exchanged basis, created by additional cash or by recognized gain. This piece is treated as a newly placed asset. Residential rental property gets a fresh 27.5-year recovery period; nonresidential real property gets 39 years.⁵⁶ Both pieces appear on Form 4562, so a single property typically produces two depreciation line items: one continuing the old schedule and one starting new.

Investors who trade up meaningfully benefit from this split. The excess basis begins a full new recovery period, which lifts deductions in the early years of ownership.

Why Your Basis Matters Later: Depreciation Recapture

A 1031 exchange defers gain; it doesn’t erase it. Each exchange pushes the deferred gain into a lower basis in whatever property you’re holding. When you finally sell without another exchange, that accumulated deferred gain lands, and part of it is taxed at a rate that catches people off guard.

The portion of gain attributable to depreciation, including depreciation rolled forward from prior exchanges, is unrecaptured Section 1250 gain, taxed at a maximum rate of 25%. The rest of the gain is taxed at the long-term capital gains rate of 15% or 20%.⁷

That is the reason tracking basis carefully through every exchange matters. After three successive 1031 exchanges over 20 years, the recapture embedded in your current property’s basis includes cumulative depreciation from all four properties. Losing the paper trail doesn’t erase the tax; it just makes the final calculation painful.

Reporting the Calculation on Form 8824

You report the exchange on Form 8824. It runs in three parts: a description of the properties, the gain-or-loss computation, and the basis of the replacement property on line 25. If Section 1250 property is involved, lines 25a through 25c allocate the basis among property types.⁴

The inputs the form needs are the adjusted basis of the old property (line 18), boot received (line 15), the fair market value of the like-kind property received, and your exchange expenses. The form’s math produces recognized gain on line 23 and replacement basis on line 25. From there, Form 4562 handles depreciation each year, with separate entries for exchanged basis and excess basis.⁵

Keep detailed records for every exchange in the chain. If you’ve completed more than one, the basis of your current property is the product of every prior adjustment. Reconstructing that history years later, especially if your original qualified intermediary or closing agent is no longer around, is one of the most expensive accounting exercises in real estate.

1
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
2
Internal Revenue Service. About Form 8824, Like-Kind Exchanges
3
Internal Revenue Service. Topic No 703, Basis of Assets
4
Internal Revenue Service. Instructions for Form 8824
5
Internal Revenue Service. Form 4562 – Depreciation and Amortization
6
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
7
Internal Revenue Service. Topic No 409, Capital Gains and Losses