Short answer: When you sell a 1031 exchange property for cash, you pay tax on all the gain you deferred in earlier exchanges plus any new gain. Your low carryover basis means a bigger taxable gain, and past depreciation is taxed at up to 25%. You can keep deferring with another 1031 exchange, or hold until death for a step-up.
Reviewed by Jon Hilley. Last updated September 29, 2026.
A 1031 exchange defers tax; it doesn't erase it. The gain you rolled over is built into the replacement property through a lower basis, so when you eventually sell for cash, the deferred gain and any new appreciation are taxed together. That includes depreciation you claimed on every property in the chain. How that plays out depends on what you do next, including whether the property later becomes your residence, which is where 1031 exchanges and your home intersect.
You have options. You can sell and pay the tax, do another exchange and keep deferring, convert the property to personal use under strict limits, or hold it until death so your heirs get a stepped-up basis.
Key rules
- Carryover basis: your replacement basis is your old adjusted basis, adjusted for boot and added cash, so the deferred gain stays embedded in the new property (IRC §1031(d)).
- Depreciation catches up: the part of your gain from prior depreciation is taxed at up to 25% as unrecaptured §1250 gain when recognized (IRC §1(h)(6)).
- No statutory minimum holding period: what matters is your intent to hold for investment at the time of the exchange; many advisors suggest holding at least 1-2 years (IRC §1031(a)(1)).
- Related-party exchanges: if you acquired the property from a related party, both sides must hold for 2 years or the deferred gain is triggered (IRC §1031(f)).
- Home sale exclusion limit: if you move into property acquired in an exchange, you can't use the §121 exclusion on its sale within 5 years of acquiring it (IRC §121(d)(10)).
What happens when you sell a 1031 exchange property for cash
Your taxable gain is the net sale price minus your adjusted basis. Because the basis carried over from the property you gave up, the gain includes everything you deferred. Depreciation continues on the carried-over basis on the old schedule, and any extra basis from added money is depreciated as new property, so your basis keeps shrinking the longer you hold.
The gain is taxed in layers: first the depreciation portion at up to 25%, then the rest as long-term capital gain at 0%, 15% or 20%, plus the 3.8% net investment income tax where it applies, plus state tax. You report the sale of a rental on Form 4797.
How soon can you sell a 1031 exchange property?
The law doesn't set a minimum, but a quick sale is evidence you didn't acquire the property to hold for investment. If the IRS concludes you bought it to resell, the original exchange can be disallowed. We generally see investors hold replacement property for at least a year, and many aim to span two tax returns. A sale soon after the exchange because of a real change in circumstances is easier to defend than one that was planned from the start.
Ways to keep deferring
- Another 1031 exchange: there is no limit on how many times you exchange. Each one rolls the prior deferred gain forward.
- Hold until death: heirs generally receive a basis equal to fair market value at death, so the deferred gain is never taxed (IRC §1014).
- Convert to a residence: possible, but under the 1031 exchange 5-year rule the §121 exclusion is unavailable for 5 years after the exchange, and periods of nonqualified use reduce the exclusion (IRC §121(b)(5)).
- Installment sale: spreads capital gain over the years you receive payments, but any ordinary depreciation recapture is taxed in the year of sale (IRC §453(i)).
Selling a 1031 exchange property at a loss
Because your basis carried over, a sale price below what you paid for the current property can still produce a taxable gain. You only have a loss if the net sale price is below your adjusted basis. On a taxable sale of a rental held more than a year, that loss is generally a §1231 loss reported on Form 4797. If you exchange instead, the loss isn't recognized and carries into the new property's basis (IRC §1031(c)).
Example: selling a property acquired in a 1031 exchange
Assume a 20% federal capital gains rate, 25% on depreciation, plus the 3.8% net investment income tax; state tax not included. Sale prices are net of selling costs.
- Original property purchase price: $300,000
- Depreciation taken on original property: $100,000 (adjusted basis $200,000)
- Exchanged for replacement property worth: $600,000 (all $400,000 of gain deferred)
- Basis of replacement: $600,000 - $400,000 deferred gain = $200,000
- Additional depreciation on replacement: $60,000 (adjusted basis $140,000)
- Later sale price: $750,000
- Total gain: $750,000 - $140,000 = $610,000
- Depreciation portion: $160,000 x 25% = $40,000
- Remaining gain: $450,000 x 20% = $90,000
- Net investment income tax: $610,000 x 3.8% = $23,180
- Total federal tax: $153,180
The $400,000 deferred in the first exchange is taxed now along with the $150,000 of new appreciation and the $60,000 of new depreciation. If you exchange into a property worth at least $750,000 instead, and reinvest all the proceeds, the full $610,000 stays deferred. The depreciation recapture calculator can help you estimate the 25% layer on your own property.
Other questions investors ask
Do you eventually pay taxes on a 1031 exchange?
Only if you sell for cash or receive boot. You can keep exchanging with no limit on the number of exchanges, and if you still own the property at death your heirs generally receive a basis equal to its fair market value, so the deferred gain is never taxed (IRC §1014).
Can you live in a 1031 exchange property after 2 years?
You can move in, but if you later sell, you can't use the §121 exclusion until 5 years after you acquired the property in the exchange, and the exclusion is reduced for rental years after 2008. Moving in soon after the exchange can also undercut the investment intent the original exchange depended on.
What is the 2 year rule for 1031?
It usually means the 2-year holding requirement for exchanges between related parties (IRC §1031(f)), though people also use it for the 24-month vacation home safe harbor. See What is the 2-year rule for a 1031 exchange?
Common mistakes
- Forgetting the depreciation from earlier properties: we see investors estimate tax using only the depreciation on the current building. Depreciation from every property in the chain is part of the 25% layer.
- Selling too quickly: a replacement listed for sale within months of closing invites questions about whether you held it for investment.
- Losing the basis trail: your basis runs back through every exchange in the chain. We see investors who can't find old Form 8824s and closing statements, which makes the final gain hard to prove. Keep them with the current property's records.
- Moving in and selling within 5 years: the most common problem we see with converted properties is an owner who expects the §121 exclusion and finds the 5-year rule blocks it.
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