Suspended passive losses and a 1031 exchange
A 1031 frees nothing. Boot is gain that stuck losses can absorb. A worked example and the checks to run.
By Hans Goldstein, Enrolled Agent, admitted to practice before the IRS ·
Why a 1031 does not release the losses
The release rule applies when you dispose of your entire interest in a transaction in which "all gain or loss realized on such disposition is recognized" (IRC 469(g)(1)(A)). A 1031 exchange exists to defer the gain on the property you reinvest (IRC 1031).
Because gain is deferred, the sale is not a fully taxable disposition. The Form 8582 instructions say suspended losses carry forward until used against passive income, against the special allowance, or when you "sell or exchange your entire interest in the activity in a fully taxable transaction to an unrelated party." A 1031 is not that.
Boot is the exception that works for you
Boot is anything you receive other than like-kind property: cash, a note, other property, or relief from debt that you do not replace. You recognize gain up to the lesser of the boot or your realized gain (IRC 1031(b)). Gain recognized on a rental you used in a passive activity is passive income (Pub. 925). Your suspended and current losses can absorb it.
Ray's exchange. Ray sells his rental for $1,500,000, with an adjusted basis of $500,000, so his realized gain is $1,000,000. He rolls the proceeds into a replacement property and takes $300,000 in cash as boot. He recognizes $300,000 of gain (ignoring the order in which recapture is recognized).
He has $300,000 of suspended losses and $300,000 of salary, and files jointly in 2026. The boot gain is passive income, so on Form 8582 it allows $300,000 of his losses. Those allowed losses are an ordinary deduction that comes off his salary, while the boot gain is taxed at its own long-term rate. The other $700,000 of gain is deferred.
| Case | Federal income tax | Change |
|---|---|---|
| Salary only, no exchange | $49,468 | |
| Exchange with $300,000 of boot and no suspended losses | $94,468 | +$45,000 |
| Exchange with $300,000 of boot and $300,000 of suspended losses | $25,335 | −$24,133 |
That is the same swap described on the allowed-versus-rate page: the loss comes off the salary layer, which is taxed higher, and the gain keeps its lower rate. The table is federal income tax only. The 3.8% tax and state tax follow their own rules, and the order in which depreciation recapture is recognized can raise the rate on part of the boot.
What is different from a full sale: the release is capped at the size of the boot gain, not the whole $300,000 balance, and the losses used are used up. If the boot were $100,000, only $100,000 of losses would be allowed and $200,000 would stay suspended. The deferred gain follows Ray into the replacement property.
| Full cash sale | 1031 with $300,000 boot | |
|---|---|---|
| Gain recognized this year | $1,000,000 | $300,000 |
| Suspended losses allowed this year | All $300,000 | $300,000, equal to the boot gain |
| Gain deferred into the replacement | $0 | $700,000 |
| Losses can exceed the gain and offset salary | Yes | No, the allowance stops at the boot gain |
Things to check
- Debt relief is boot unless you take on equal or greater debt on the replacement (Reg. 1.1031(d)-2).
- Recapture order. Gain recognized as boot is characterized under the usual rules, depreciation recapture first. See 1031 boot.
- Installment boot. Boot paid over years can be reported on the installment method (IRC 453(f)(6)), spreading the gain so that new passive losses can also absorb it year by year.
- Related-party rules. Exchanges with a related person carry their own restrictions.
- Estate tax. A 1031 fixes income tax only. If your estate may exceed the federal exemption, see the estate plan comparison.
Play with it
Drag the sliders and watch where the released loss lands. The first lesson is the rate swap on this page. The other three cover an installment sale, the pile-up that follows a one-year sale, and a 1031 exchange with boot.
Open the Playground full screen. Rough 2026 estimate for education.
For the whole picture, see the 1031 exchange page and the complete guide to suspended losses.
Sources and dates
- 26 USC 469(g)(1)(A); 26 USC 1031(b), (d).
- 2025 Instructions for Form 8582, "Purpose of Form"; IRS Publication 925 (2025), Passive Activity and At-Risk Rules, "Passive Activity Income."
- 26 USC 453(f)(6).
Checked against the sources above on October 30, 2026. Dollar figures are 2026 federal (Rev. Proc. 2025-32) unless the page says otherwise. Education only, not tax or legal advice for your situation.
Questions
Do suspended passive losses carry over in a 1031 exchange?
They stay suspended. A 1031 exchange is not a transaction in which all realized gain is recognized, so IRC 469(g)(1)(A) does not release them. Your preparer carries them forward and they come out when you later dispose of the replacement in a fully taxable sale, or against passive income in the meantime.
Is boot in a 1031 exchange passive income?
Recognized gain on a rental property sold in a 1031 with boot is gain from the disposition of property used in a passive activity, which is passive income (Pub. 925). Suspended and current passive losses can absorb it on Form 8582.
How much boot can I take for little tax?
In round terms, boot up to the size of the suspended losses. The boot gain is recognized (the lesser of the boot or the realized gain, IRC 1031(b)), the losses are allowed against it and come off other income, so the cash comes out with little or no net tax on that slice.
Past that line the extra boot is taxed with no offset. Debt relief you do not replace counts as boot.
Does a failed 1031 exchange release the losses?
If the exchange fails, the sale is a taxable sale of your entire interest to an unrelated buyer, and the release rule applies. Confirm the buyer is unrelated and that you did not keep part of the activity.
Should I skip the 1031 because of the suspended losses?
Not automatically. A 1031 defers the whole tax on the gain you reinvest. A taxable sale releases the losses but pays tax on the gain. Compare the two, including depreciation recapture, the swap and the estate plan.
Related
- Suspended passive losses: the complete guide
- Suspended losses and an installment sale
- Do passive losses offset capital gains?
- Passive loss carryover
- All passive loss guides
Run my numbers with Hans: book a scope call
Hans Goldstein is an Enrolled Agent, admitted to practice before the Internal Revenue Service. Not affiliated with or endorsed by the IRS. He is not a CPA or attorney. Education only, not tax or legal advice for your situation.