Splitting a 1031: Take Some Cash, Roll the Rest into a DST

Most landowners think a 1031 exchange is all or nothing. Roll everything into the replacement property or pay tax on the full sale. That’s not quite right.

You can split a 1031 exchange. Take some cash at closing, pay the tax on that portion, and roll the rest into a Delaware Statutory Trust on a tax-deferred basis. The IRS calls the cash portion “boot,” and a partial exchange is a perfectly normal structure when it fits the family’s situation.

When a split exchange makes sense

Five reasons we see most often.

The family needs cash now. A medical situation, paying down personal debt, gifting to a child, building a cash reserve. Sometimes the timing of a land sale lines up with a real cash need that can’t wait. Taking partial cash at closing and rolling the rest is cleaner than borrowing against a DST later.

Pre-paying the tax bill while it’s manageable. Some families would rather clear half the deferred tax now and carry forward a smaller deferred liability than carry the full liability into the next decade. It’s a comfort level decision more than a math decision.

Estate alignment. A landowner heading into estate planning may want to put the bulk of the proceeds into a DST that heirs will inherit at a stepped-up basis, while taking enough cash now to fund a charitable gift, life insurance, or a planned distribution to a non-DST asset.

Right-sizing the DST allocation. DST offerings come in fixed minimum increments. Sometimes the available DST allocation doesn’t match the full sale amount, and taking the difference as cash is the cleanest way to make the math work.

Replacement property is smaller than the sale. If the replacement DST is structured for a smaller dollar amount than your sale, the difference becomes boot.

How the math works

Imagine you sell your land for $3 million. After paying off any debt on the property, you have $2.5 million in equity to deploy.

You decide to take $500,000 in cash and roll $2 million into a DST.

The $500,000 in cash is taxable boot. You pay capital gains tax (federal plus state, plus depreciation recapture if applicable) on that portion. Depending on your state and your basis, that might be in the range of 20 to 35 percent of the cash portion.

The $2 million rolled into the DST keeps its tax-deferred status. The DST satisfies the equal-or-greater requirements proportionally on the rolled portion, including the debt-replacement piece, because DST debt is non-recourse and built in.

You walk away with cash in hand and a DST interest generating potential mailbox money on the rest.

The debt-replacement piece

This is where partial exchanges trip people up. The IRS requires you to replace not just equity, but debt, on the portion you’re rolling forward.

If you sold land that carried a $1 million recourse loan, and you’re rolling $2 million of equity into a DST, the IRS still wants to see at least $1 million of debt replacement applied proportionally on the rolled side, or the equivalent in additional cash on top of the rolled equity.

DSTs come pre-packaged with non-recourse debt. In most cases the structure handles the debt-replacement requirement automatically on the portion you roll. Your CPA and your advisor should walk through the math with you before closing.

The CPA conversation matters

A split exchange has more moving parts than a full one. We always tell clients to get a pre-closing tax estimation from their CPA before the sale. The CPA can confirm:

• Your basis in the original property
• Your projected capital gain
• Your projected depreciation recapture
• Your state-level tax exposure
• The federal and state tax owed on the cash portion you’re taking

That number tells you whether the cash portion you’re planning is worth what you’ll pay. Sometimes a $500,000 cash take produces a $150,000 to $200,000 tax bill. Some families decide that’s worth it. Some decide to roll everything and revisit liquidity later.

When a split exchange does not fit

Two common situations where we’d push back.

The cash isn’t really needed. If the cash you’re planning to take is going to sit in a savings account because “it just feels safer,” the after-tax cash is usually less productive than the deferred amount working inside a DST. We’ll say that out loud.

The deferred tax is large and the family plans to hold to death. If the entire deferred amount would otherwise be eliminated through the heirs’ stepped-up basis, paying tax on a partial cash take now reduces what gets stepped up later.

The risks of a partial exchange

Same risks as any DST: illiquidity for the rolled portion, no guarantee on income or principal, market exposure on the underlying real estate. The cash portion is just cash, with whatever tax bill follows.

The big picture

Splitting a 1031 is a normal, IRS-recognized structure. Take what you need now. Defer what you can. Rebalance later if circumstances change.

The visit is how we figure out which split makes sense, or whether one fits at all.