Can You Take Cash Out of a 1033 Exchange?

Ray wasn’t planning to sell his land, but the state needed it for a new highway. He had held the property as an investment, though it produced no income.

Now, at 64, he faced a new question: how much of the $1.8 million condemnation award could he keep for retirement after paying off his loan, buying replacement property, and accounting for taxes? Ray isn’t a client of ours. He’s an example we use to walk through the 1033 rules.

He had heard of a 1031 exchange, where taking cash out usually means recognizing gain. But because the state took his land through eminent domain, he had another option: a 1033 exchange. Two free calculators from NexTrend Securities helped Ray explore whether he could defer his gain, reinvest in real estate, and keep part of the award.

What Does Ray Actually Have?

Ray bought the land for $600,000. He made no improvements and took no depreciation because land is not depreciable. The state pays him $1.8 million, and he pays off a $300,000 loan. He also spends $60,000 on qualifying legal and appraisal costs to obtain the award.

After those payments, Ray has $1,440,000 in cash. His gain is a different calculation: the $1,740,000 net award minus his $600,000 tax basis equals $1,140,000. To defer that entire gain, his qualifying replacement property must cost at least $1,740,000.

The loan payoff is the detail that catches Ray’s attention. It reduced his bank balance, but it did not reduce his replacement target. Buying $1,740,000 of debt-free property would require another $300,000 from his pocket.

Does He Have to Buy More Land?

Ray enters his information into NexTrend’s 1033 Exchange Calculator. Because the state condemned land held for investment, he can consider other qualifying investment real estate. He doesn’t have to replace an empty parcel with another empty parcel.

That suits Ray. His land produced no income, and he would prefer an investment that could help fund his retirement. He considers Delaware Statutory Trusts, or DSTs, which offer fractional ownership of professionally managed real estate. A qualifying DST interest may serve as replacement property, though income is not guaranteed.

How Ray Could Keep $570,000

Next, Ray opens the 1033 Cash Out Calculator to compare financing options. He considers a qualifying DST investment with 50% financing. Half of his total replacement cost would come from his cash investment, and half from his share of the DST’s debt:

What if Ray wants to keep $570,000 but chooses a debt-free DST? He would invest the remaining $870,000, leaving him $870,000 below his replacement target. That makes $870,000 of his gain taxable. Part of the $570,000 he kept would then go toward his tax bill, leaving less for retirement.

With the financed DST, his cash investment plus his share of the debt meets the full replacement target. He could defer all of his gain and keep $570,000 without owing tax on that gain now. The debt that makes this work is also the risk. Leverage magnifies losses if the property underperforms.

How Is This Different From a 1031?

In a typical deferred 1031 exchange, a qualified intermediary holds the sale proceeds while the investor arranges the replacement purchase. If the investor takes some of that money as cash, it generally becomes taxable, up to the amount of the gain. Borrowing more to buy the replacement property does not eliminate the tax on that cash.

Ray’s 1033 allows him to receive the condemnation award directly without a qualified intermediary. He then purchases qualifying replacement property and makes the required tax election. Financing can help him meet his replacement target while retaining cash.

Ray also has more time. A typical deferred 1031 exchange requires identifying replacement property within 45 days and completing the purchase within 180 days. If the tax return for that year is due before day 180, the exchange ends on that earlier date unless an extension is filed. For condemned investment real estate like Ray’s, the 1033 replacement deadline is three years after the end of the tax year in which the gain is first realized.

Other 1033 situations need different assumptions. Casualty losses, thefts, personal residences, and certain disaster-related conversions can involve different replacement rules or deadlines.

This article is provided for general educational purposes only and does not constitute tax or investment advice. The scenario presented above is entirely hypothetical and is provided for illustrative purposes only. It does not represent the actual experience, performance, or portfolio of any specific investor or client of NexTrend Securities. Actual eligibility, costs, debt treatment, and tax results depend on the transaction and the investor’s circumstances. DST investments involve risk, including illiquidity and potential loss of principal, and are suitable only for accredited investors. Income is not guaranteed. Consult your tax advisors regarding your individual situation. NexTrend Securities is not a tax advisor and does not provide tax advice.