When considering a 1031 exchange, one of the key requirements is that the replacement property must be of equal or greater value than the relinquished property to achieve full tax deferral. However, it is possible to exchange for a lesser value property, but this will result in a partial exchange and may trigger some taxable gain, known as "boot."

Boot is any non-like-kind property received in the exchange, which can include cash, debt relief, or other property that is not considered like-kind. When you exchange for a property of lesser value, the difference in value is considered boot and is subject to capital gains tax.

Let's break this down with an example:

1. Sale of Relinquished Property: You sell your rental property for $500,000. After paying off the $200,000 mortgage, you have $300,000 in net proceeds.
2. Purchase of Replacement Property: You use the $300,000 to purchase the new property worth $400,000. To complete the purchase, you take out a new mortgage of $100,000 on the replacement property.
3. Boot Calculation: Since the replacement property is worth $400,000, which is $100,000 less than the relinquished property, this $100,000 difference is considered boot. Additionally, if you receive any cash from the transaction, that would also be considered boot.
4. Tax Implications: The $100,000 boot is subject to capital gains tax. The rest of the transaction qualifies for tax deferral under Section 1031, meaning you defer the gain on the remaining $400,000 of the transaction.

By using Deferred.com as your qualified intermediary, we ensure that the exchange is structured correctly, and you comply with all IRS regulations. Our "No Fee Exchange" service helps you save money, allowing you to reinvest more of your equity into the replacement property.

While exchanging for a lesser value property can result in some taxable gain, it can still be a strategic move if you have specific investment goals or need to adjust your portfolio. Always consult with a tax advisor to understand the full implications and to plan effectively for your financial situation.