A 1031 exchange lets you sell an investment property, roll the money into a new one, and put off the tax on your gain. Real estate investors use it to trade up all the time. But the IRS does not let you start over with a clean basis. Part of your old property's tax history moves with you into the new one.
That history changes how cost segregation works on the replacement property. This guide walks through what carries over, what counts as brand new, and why a study is still worth running after an exchange.
The big idea: your new property's basis splits into two pieces. One piece keeps depreciating on your old property's clock. The other piece is brand new money, and it qualifies for a full cost segregation study just like any ordinary purchase.
Two kinds of basis, not one
Under the tax rules for like-kind exchanges (Treas. Reg. §1.168(i)-6), the property you receive is not treated as one single purchase. It is split into two pieces:
- Exchanged basis (carryover). This is the adjusted basis you carried over from the property you sold. It keeps depreciating the same way it already was, on the same recovery period, for whatever years are left. Reg. §1.168(i)-6(c)(1).
- Excess basis. This is any extra money you put in to complete the trade, like added cash or new debt. The rules treat this part as if you bought it new on the day the exchange closed. Reg. §1.168(i)-6(c)(2).
Your CPA can also elect out of this split and treat the whole new basis as placed in service on the exchange date instead. That election is in Treas. Reg. §1.168(i)-6(i). It is a return-level choice for your tax advisor, not something a study decides on its own.
Where cost segregation applies
The excess basis is exactly what a cost segregation study is built for. Because the rules treat it as new property, it can be sorted into 5, 7, and 15-year parts and can qualify for bonus depreciation, the same as any other purchase. If you added meaningful cash or new financing to complete the exchange, there is real new basis sitting there to study.
The carryover basis works differently. It keeps depreciating on the old property's schedule, over whatever is left of that recovery period and using the same method. Treas. Reg. §1.168(i)-6. It does not start over, and it does not pick up bonus depreciation. So the study itself is applied to the excess basis, the new money. Whether any part of the carryover basis can also be broken into component lives depends on how the property you sold was reported, and that is a question for your tax advisor. Ask your CPA before you count on it.
Never studied the property you sold? Start here.
This is the most common case we see. Most owners never ran a cost segregation study on the property they exchanged out of, so the carryover basis has been sitting on the slow schedule the whole time. A look-back study on the property you sold can correct how that basis was classified, through the catch-up rules on Form 3115, and the corrected lives then carry into the replacement property under the same regulation. That is a call for your tax advisor to make on your file, and a full study still applies to any new excess basis. Owned the old property for years? See how the catch-up rules work.
Two pieces of basis, two different clocks, and often two reasons to run the study.
What happens to the fast depreciation when you sell
Fast depreciation is not free forever. When you eventually sell the replacement property without doing another exchange, some of what you deducted can come back as tax. This is called recapture.
Property that depreciates as personal property brings back every dollar as ordinary income, capped at your gain. Real property works differently. Only the part depreciated faster than straight line comes back as ordinary income, and that includes bonus depreciation. What is left is taxed at no more than 25%. Do another 1031 exchange at that point, and you defer both kinds again. It does not erase them, it pushes them further down the road.
See how recapture fits into the bigger worth-it math.
When a study still makes sense after an exchange
As a rule of thumb, a study is worth running after a 1031 exchange when either of these is true:
- You added real money to the deal. New cash or new debt created excess basis, and that basis is fully eligible for a fresh study.
- The property you sold was never studied. A look-back study may correct how that carryover basis was classified through the catch-up rules. Ask your tax advisor whether that fits your file.
In practice, most exchanges hit at least one of these, so most exchanges are still worth a look.
Next step:See your savings range in seconds for the property you exchanged into, or readis a cost segregation study worth it? for the general math.
This guide explains general tax ideas in plain words. It is not tax advice for your situation. The basis split on a 1031 exchange, the election out under Treas. Reg. §1.168(i)-6(i), and recapture at sale all turn on your exact facts. Your study and tax positions are reviewed by a licensed tax professional. Always confirm the plan with your own advisor, and coordinate the exchange paperwork (including Form 8824) with your CPA before you file.