A hybrid 1031 exchange, also called a “partial 1031 exchange,” allows real estate investors to defer capital gains taxes on part of their property sale while taking some cash out for personal use. It’s a middle ground between a full 1031 exchange and a taxable sale.
The Basics of a Standard 1031 Exchange
First, a quick refresher: A traditional 1031 exchange lets you sell an investment property and buy a replacement property of equal or greater value without paying capital gains taxes. The key requirement is reinvesting all proceeds into the new property within the allocated timeline of the 1031 exchange.
What Makes It “Hybrid”?
In a hybrid 1031 exchange, you don’t reinvest the entire sale proceeds. Instead, you keep some cash (called “boot”) and only defer taxes on the portion you reinvest. This gives you flexibility to access some equity while still enjoying partial tax deferral.
This is also applicable in a situation where an investor may own two separate properties and is trying to consolidate them into a single property but is only able to sell one property immediately and needs more time to sell the second property but has identified the target property.
How It Works
Let’s say you sell a rental property for $500,000 with a $200,000 capital gain. In a hybrid exchange, you might:
- Reinvest $400,000 into a new property
- Keep $100,000 as cash
The tax outcome: You’ll pay capital gains tax only on the $100,000 you kept, while deferring taxes on the remaining $300,000 reinvested. This is far better than paying taxes on the full $500,000 gain if you didn’t do a 1031 at all.
This 1031 exchange can also be financed with a special purpose mortgage loan designed to satisfy the 1031 exchange.
Important Rules to Remember
The same 1031 exchange deadlines still apply:
- 45 days to identify replacement properties
- 180 days to close on the new property
You must also use a qualified intermediary (i.e. 1031 exchange accommodator) to hold the funds—you can’t touch the money directly during the exchange period.
The “boot” (cash you keep) can come from:
- Not reinvesting all sale proceeds
- Reducing debt on the replacement property
- Receiving personal property as part of the deal
Is a Hybrid 1031 Right for You?
A hybrid exchange makes sense when you want to:
- Access some cash for other investments or personal needs
- Downsize to a smaller property while still deferring some taxes
- Diversify without triggering a full taxable event
However, you’ll want to work with a CPA or tax advisor to calculate exactly how much you’ll owe on the boot portion and ensure the math works in your favor. It is also important to get in contact with a 1031 exchange accommodator in advance to identity if this is an ideal vehicle to transact.
Bottom Line
A hybrid 1031 exchange offers flexibility that a full exchange doesn’t, letting you balance tax deferral with liquidity. Just remember: any cash or debt relief you pocket will be taxable, so plan accordingly.
If you’re thinking about buying, selling, or refinancing and want to understand your options, give us a call at Bluefire Mortgage Group: (760) 930-0569. We’re here to help you navigate the market with confidence.
