Short answer: No, it isn't a legal requirement, but it is the only way to defer all your tax. If the replacement property costs less than your net sale price, the difference is usually taxable boot. To defer 100%, buy equal or greater value, reinvest all your net cash, and replace any paid-off mortgage with new debt or added cash.
Reviewed by Jon Hilley. Last updated September 29, 2026.
"Equal or greater value" is a planning target, not a rule in the statute. You can buy a less expensive replacement property in a 1031 exchange and still have a valid exchange. The shortfall is simply taxed, because it shows up as cash you kept or debt you shed. Understanding how that works is the core of boot in a 1031 exchange.
Value alone isn't the whole test either. You can buy a more expensive property and still owe tax if you take cash out at closing, because new debt doesn't offset cash you receive.
Key rules
- Boot is taxable: gain is recognized up to the amount of cash and other non-like-kind property you receive (IRC §1031(b)).
- Debt relief counts as cash: a mortgage paid off on the relinquished property is treated as money received, offset by debt you take on or cash you add (Treas. Reg. §1.1031(d)-2).
- New debt doesn't cancel cash boot: taking a larger loan on the replacement won't shelter cash you pulled out of the exchange (Treas. Reg. §1.1031(d)-2).
- Tax limited to your gain: recognized gain is the smaller of your realized gain or the boot (IRC §1031(b)).
- Basis adjusts: the replacement property's basis reflects any gain recognized and cash added (IRC §1031(d)).
Replacement property rules: three tests for full deferral
- Price: the replacement property in a 1031 exchange costs at least your net sale price (sale price minus exchange expenses such as commissions, title fees and the QI fee).
- Equity: all net proceeds held by your qualified intermediary go into the purchase.
- Debt: any mortgage paid off at the sale is replaced by a new loan, by cash you add, or both.
Miss any one and you have boot. That doesn't end the exchange; it just means part of the gain is taxable in the year of the sale.
Why "net" sale price matters
Transaction costs paid from the proceeds, like broker commissions and escrow fees, reduce the amount you need to reinvest. Other items paid from exchange funds, such as loan fees, repairs, prorated rents or security deposits, don't reduce it and can create boot. Ask your QI and closing agent to review the settlement statement before closing.
Paying off your mortgage at closing doesn't lower the target. You still need replacement property worth at least your net sale price; the payoff only means part of that price has to come from new debt or your own cash.
What if the replacement costs more?
Buying up is fine and common. The extra cost can come from a larger loan, your own cash, or both, and none of it is taxed. Cash you add also increases your basis in the new property, which means more depreciation going forward. The one trap is cash coming back to you: if the new lender funds more than you need and you receive money at closing, that cash is boot even though the property is worth more than the one you sold.
If you can't find a property at the full price, you can also buy two or more replacements whose combined price meets the target, subject to the identification limits. Some investors fill a gap with a Delaware statutory trust interest, which often comes with its own debt and can close quickly. Adding your own cash at closing also offsets debt relief.
Example: buying a less expensive replacement
Assume you took more than $90,000 of depreciation, so the boot is taxed at 25%, plus the 3.8% net investment income tax; state tax not included.
- Sale price: $1,000,000
- Selling costs (exchange expenses): $60,000
- Net sale price: $940,000
- Mortgage paid off: $400,000
- Net equity held by the QI: $540,000
- Adjusted basis: $500,000
- Realized gain: $440,000
- Replacement price: $850,000 ($540,000 equity + $310,000 new loan)
- Net debt relief (boot): $400,000 - $310,000 = $90,000
- Recognized gain: $90,000
- Federal tax: $22,500 (25%) + $3,420 (3.8%) = $25,920
- Deferred gain: $350,000
- Basis of replacement: $850,000 - $350,000 = $500,000
You reinvested every dollar of equity, but because the new property cost $90,000 less than your $940,000 net sale price, you ended up with $90,000 less debt, and that is taxed. Buying a $940,000 property with a $400,000 loan would have deferred the full $440,000. You can test different prices with the partial boot calculator.
Other questions investors ask
Can you do a 1031 exchange on a property of lesser value?
Yes. The exchange is still valid, and you pay tax only on the boot: the value gap, cash you keep or debt you don't replace, up to your realized gain. See How do you calculate the gain on a partial 1031 exchange?
How do I calculate the basis of replacement property in a 1031 exchange?
Take the replacement price and subtract the gain you deferred. The same result comes from your old adjusted basis, minus cash received, plus gain recognized, plus extra cash paid (IRC §1031(d)). In the example above, $850,000 minus $350,000 of deferred gain gives a $500,000 basis.
What are the rules for buying replacement property in a 1031 exchange?
It must be like-kind real property held for investment or business use, identified in writing within 45 days, acquired within 180 days, bought by the same taxpayer that sold, and paid for through your qualified intermediary. See What property qualifies for a 1031 exchange?
Common mistakes
- Matching equity but not price: the most common problem we see is an investor who reinvests all the cash but buys a smaller property with a smaller loan, not realizing the debt reduction is boot.
- Refinancing to pull cash out at closing: we see buyers take a bigger loan on the replacement and receive cash back. The larger loan doesn't offset that cash.
- Paying non-exchange costs from proceeds: loan fees and security deposit credits paid from exchange funds quietly create taxable boot.
Run the numbers: try our free Partial 1031 (Boot) Calculator.
