Capital gain recognized on 1031 boot can go into a Qualified Opportunity Fund (QOF) when the sale or exchange was with an unrelated person and an amount up to that gain is invested within 180 days of the day the gain would be recognized (IRC §1400Z-2(a)(1) and Treas. Reg. §1.1400Z2(a)-1(b)(7)), but the part of the boot gain that is ordinary recapture cannot. Cost segregation then works differently on each route: a 1031 replacement property generally keeps its exchanged basis on the old depreciation schedule, while a QOF project starts with new basis a cost segregation study can reclassify.
Boot is the part of a like-kind exchange that IRC §1031 does not defer, so the real choice is what to do with the recognized part: pay the tax on it, avoid it by buying more replacement property, or defer the eligible gain in a QOF whose cost segregation deductions run on the fund's own basis. This post covers boot in a partial exchange; for an exchange that fails outright, see when a QOF can rescue a failed 1031 exchange.
Why does a 1031 exchange not defer boot?
A 1031 exchange does not defer boot because IRC §1031(b) recognizes gain up to the sum of the money and the fair market value of the other property received, and boot is the shorthand for that money and other property. Debt counts too: under IRC §1031(d) and Treas. Reg. §1.1031(d)-2, a liability the other party takes over is treated as money received, net of the liabilities the investor takes on and the cash the investor pays.
The rest of the exchange keeps its deferral, which is why the two tools are not substitutes. Full deferral under IRC §1031 depends on reinvesting the full sale value into like-kind real property, while IRC §1400Z-2 defers only gain, up to the amount invested in a QOF.
Which part of 1031 boot is eligible gain for a QOF?
Only gain treated as capital gain, or a qualified 1231 gain, is eligible gain under Treas. Reg. §1.1400Z2(a)-1(b)(11)(i), so the ordinary recapture inside boot cannot be deferred into a QOF. A section 1231 gain counts only to the extent it exceeds the amount treated as ordinary income on the property (Treas. Reg. §1.1400Z2(a)-1(b)(11)(iii)).
A cost segregation study on the relinquished property is what makes that limit bite. Gain on the reclassified 5- and 7-year property is ordinary income under IRC §1245(a)(1), and in a like-kind exchange IRC §1245(b)(4) limits it to the gain recognized plus the fair market value of acquired property that is not §1245 property, so on a building with an earlier study the recapture can use up some or all of the boot gain, and can exceed it when the replacement property holds little §1245 property. IRC §1250(d)(4) sets a separate limit on the §1250 ordinary amount. Unrecaptured §1250 gain is capital gain taxed at up to 25 percent for a noncorporate taxpayer under IRC §1(h)(1)(E), so it can be eligible gain.
The 180-day period begins on the day the gain would be recognized (Treas. Reg. §1.1400Z2(a)-1(b)(7)(i)), so boot held by a qualified intermediary needs its recognition date fixed first, as the QOF clock after an attempted exchange explains.
When does gain deferred into a QOF come back into income?
Boot gain invested in a QOF on or before December 31, 2026 is included in income for the tax year that includes the earlier of an inclusion event or December 31, 2026, and boot gain invested after that date for the tax year that includes the earlier of an inclusion event or the fifth anniversary of the investment (Notice 2026-40, sections 4.01 and 4.02). For a calendar-year taxpayer, boot gain recognized in 2026 and invested by December 31, 2026 therefore lands on the same 2026 return and gets no deferral past it, though the 10-year exclusion can still apply to the investment; the December 31 Opportunity Zone inclusion sets out the return mechanics.
Gain realized in 2026 whose 180-day period runs past December 31, 2026 can be invested after that date and comes under amended IRC §1400Z-2(b)(1)(B), which OBBBA §70421(c)(5)(A) applies to amounts invested after December 31, 2026. An investment held five years under those rules gets a basis increase of 10 percent of the deferred gain, or 30 percent in a Qualified Rural Opportunity Fund, which reduces the amount included. Property the QOF or its business acquires after December 31, 2026 generally has to be acquired for use in a zone designated after July 4, 2025 (Notice 2026-40, section 5.01), so the fund's own purchase date matters too (Opportunity Zone investment in 2027).
Gain deferred by the exchange itself has no such date: it stays with the replacement property until a taxable sale or a step-up at death. The IRC §1400Z-2(c) election does not change that comparison, because it applies to gain on the QOF investment, not to the deferred boot gain, which comes due under IRC §1400Z-2(b), less any five-year basis increase, however long the investment is held.
How does IRC §1031 carryover basis limit cost segregation depreciation?
IRC §1031 carryover basis limits cost segregation because Treas. Reg. §1.168(i)-6 keeps the exchanged basis on the relinquished property's remaining recovery period and method, so a cost segregation study on the replacement property generally reaches only the excess basis unless the taxpayer elects out under Treas. Reg. §1.168(i)-6(i). For depreciation purposes only, that election treats the whole replacement basis as placed in service at replacement and the relinquished property's adjusted depreciable basis as disposed of; sections 1031, 1245 and 1250 still apply. Under IRC §1031(d) the replacement basis starts from the relinquished property's basis, decreased by money received and increased by gain recognized, so a large purchase price does not by itself create a large depreciation schedule.
On the excess basis, the new cash and debt above the exchanged basis, a cost segregation study can still separate personal property and land improvements from the structural building under IRC §168(e).
A QOF project works the other way. When the QOF or its qualified opportunity zone business (QOZB) buys or builds property that is original-use or substantially improved under IRC §1400Z-2(d)(2)(D), the entity depreciates its own cost basis under IRC §168, and a cost segregation study can reclassify part of it into 5-, 7- and 15-year property instead of leaving it on the 27.5- or 39-year schedule under IRC §168(c). Cost segregation does not create basis; it changes when the deductions on existing basis arrive.
If you are comparing study providers, our guide to the best cost segregation companies sets out what to ask a provider. For zone-specific depreciation planning, our Opportunity Zone cost segregation page covers QOF property.
Does the 10-year OZ election cover depreciation recapture when boot gain funds the QOF?
The 10-year election treats the part of a QOF interest funded with eligible boot gain like any other deferred gain: On a qualifying investment held 10 years, an investor who elected deferral and sells the interest in a Qualified Opportunity Fund taxed as a partnership may elect to step basis to fair market value under IRC §1400Z-2(c), and on that sale the election removes both the ordinary recapture and the unrecaptured §1250 gain, which is what converts cost segregation from a timing benefit into a permanent one. If the fund sells the property, a separate election under Treas. Reg. §1.1400Z2(c)-1(b)(2)(ii) can exclude the gain for partnership or S-corporation funds, and a corporate fund gets no such election. The two transactions do not behave identically, so the exit the sponsor plans decides which election applies (the asset-sale exclusion for 10-year LPs).
On a taxable sale before year 10, recapture behaves normally: §1245 recapture on the 5- and 7-year property is ordinary income, as is §1250 recapture of the depreciation taken above straight-line (bonus included) on 15-year land improvements held more than one year, and the rest of the depreciation on those land improvements and on the 27.5- or 39-year structure is unrecaptured §1250 gain, taxed at up to 25% for a noncorporate taxpayer. Nothing about Opportunity Zone status shields that.
Two limits travel with the exclusion. Only the part of the QOF investment funded with deferred gain carries the election; under IRC §1400Z-2(e)(1) anything else invested is a separate investment without it, so the exclusion is sized by the eligible gain invested, not the sale price. For an amount invested after December 31, 2026, the amended IRC §1400Z-2(c) measures fair market value at the earlier of the sale or the thirtieth anniversary of the investment.
A Qualified Opportunity Fund interest funded with deferred gain starts at a $0 basis under IRC §1400Z-2(b)(2)(B), and partnership losses are deductible only up to basis under §704(d); a partner's share of partnership debt counts as basis under §752, so the accelerated depreciation is usually still usable. Whether it is usable depends on the investor's capital account and debt basis. The at-risk rules of IRC §465 and the passive-activity rules of IRC §469 apply as well, so for a 1031 investor used to direct ownership the entity layer can matter as much as the exit (Opportunity Zone zero basis and cost segregation deductions).
Can a 1031 replacement property get bonus depreciation?
A 1031 replacement property can get bonus depreciation, but on used property generally only the remaining excess basis is eligible under Treas. Reg. §1.168(k)-2(g)(5)(iii)(A), while a QOF or QOZB can claim 100% bonus depreciation under IRC §168(k) as amended by OBBBA 2025 on qualified property it acquires after January 19, 2025. Property acquired on or before January 19, 2025 stays on the TCJA phase-down under IRC §168(k). For that test the acquired date is not the closing date: under IRS Notice 2026-11 property bought under a written binding contract is acquired on the latest of the date the contract was signed, the date it became enforceable under state law, the end of any cancellation period and the date any contingency was satisfied, under a contract that is not binding (for example, one that limits damages to a specified amount) it is generally when more than 10 percent of the total cost, excluding land and preliminary activities, has been paid or incurred, and self-constructed property, including property built for the taxpayer under a written binding contract signed before construction began, is acquired when physical work of a significant nature begins (Treas. Reg. §1.168(k)-2(b)(5)); and used property qualifies only if the taxpayer had not used it at any time before acquiring it and the acquisition meets the §179(d) purchase rules that §168(k)(2)(E)(ii) applies (for example, it was not acquired from a related party, by gift or inheritance, or with a carryover basis).
What decides whether boot goes into a QOF or into more replacement property?
Four things decide whether boot goes into a QOF or into more replacement property under IRC §1031: how much of the boot gain is eligible, when the deferred gain comes back, how much depreciable basis each route creates and can use, and how the investment exits.
- Eligible gain. The boot gain is split by character first, because ordinary recapture cannot go into a QOF, and more replacement property avoids it only as far as IRC §1245(b)(4) and the property acquired allow.
- Timing. More replacement property keeps the gain deferred with no fixed date; a QOF brings it back on the IRC §1400Z-2(b) schedule above.
- Depreciable basis. On the replacement property, a cost segregation study generally reaches the excess basis. In a QOF taxed as a partnership, the investment that carries the election is limited to the eligible gain, and the depreciation reaches the partner through the fund agreement, IRC §704(d) and the partner's share of debt under IRC §752.
- Exit. In a QOF taxed as a partnership, a taxable exit at a gain before the 10-year hold and the IRC §1400Z-2(c) election are in place brings §1245 and §1250 recapture up to that gain, as a taxable sale of a 1031 replacement property does; a replacement property has no equivalent of that election short of a step-up at death.
To take the next step on a property already owned, start a cost segregation study; a full study still depends on records, asset detail and the reporting position used by the QOF or QOZB.
What documents do I need to put 1031 boot into a QOF?
Putting 1031 boot into a QOF typically takes the exchange closing statements, the relinquished property's depreciation schedule and any earlier cost segregation study, which set the §1245 and §1250 split of the boot, plus the amount and date of the eligible gain invested. From the sponsor it typically takes subscription documents, property acquisition files, placed-in-service support, depreciation schedules and any existing cost segregation study.
For a cost segregation study, the key records include settlement statements, contractor payment applications, architectural drawings, site plans, tenant improvement invoices, fixed-asset ledgers and renovation budgets. These records help separate land, nondepreciable costs, real property components, shorter-life personal property and land improvements under IRC §168.
Related reading: Recapture Series · Part 1 — The Three Layers of Gain When You Sell, Recapture Series · Part 2 — Allocating the Sale Across Land, Shell, and Short-Life Assets and Recapture Series · Part 3 — Partial Dispositions: Writing Off the Old Without Double-Counting.
Frequently Asked Questions
Can 1031 boot be invested in a QOF that uses cost segregation?
Capital gain recognized on 1031 boot can be invested in a QOF when the sale or exchange was with an unrelated person and the amount is invested within 180 days of the day the gain would be recognized under IRC §1400Z-2(a)(1) and Treas. Reg. §1.1400Z2(a)-1(b)(7). Ordinary recapture in the boot is not eligible gain under Treas. Reg. §1.1400Z2(a)-1(b)(11), and on the QOF route the cost segregation study is of the QOF or QOZB's own depreciable property under IRC §168.
Does a QOF election defer §1245 depreciation recapture inside 1031 boot?
A QOF election does not defer §1245 recapture inside 1031 boot, because §1245 recapture is ordinary income under IRC §1245(a)(1) and eligible gain is limited to capital gain and qualified 1231 gain; on a building with an earlier cost segregation study, that recapture can use up some or all of the boot gain under IRC §1245(b)(4).
Does debt relief count as boot in a 1031 exchange?
Debt relief counts as boot in a 1031 exchange to the extent it is not offset: under IRC §1031(d) and Treas. Reg. §1.1031(d)-2, a liability the other party takes over is treated as money received, net of the liabilities the investor takes on and the cash the investor pays. Gain recognized on that boot can be eligible for a QOF on the same terms as cash boot, to the extent it is capital gain or qualified 1231 gain.
Does 2026 boot gain invested in a QOF get deferred past 2026?
Boot gain recognized in 2026 and invested in a QOF on or before December 31, 2026 is included in the 2026 tax year for a calendar-year taxpayer, so it gets no deferral past that return, while gain invested after December 31, 2026 and within its 180-day period is included for the tax year that includes the earlier of an inclusion event or the fifth anniversary of the investment (Notice 2026-40, sections 4.01 and 4.02). An amount invested after December 31, 2026 and held five years gets a basis increase of 10 percent of the deferred gain, or 30 percent in a Qualified Rural Opportunity Fund, which reduces the amount included.
Can cost segregation make an OZ investment better than adding 1031 replacement property?
Cost segregation can favor a QOF over adding 1031 replacement property when the QOF property has meaningful new depreciable basis and the investor can use the depreciation allocated to it, because a 1031 replacement property generally keeps its exchanged basis on the old schedule under Treas. Reg. §1.168(i)-6. The comparison also has to count when the deferred gain comes back under IRC §1400Z-2(b), a partner's basis under IRC §704(d) and the form of the exit.
Does the §1400Z-2(c) election exclude depreciation recapture on a QOF interest sold after 10 years?
Depreciation recapture under IRC §1245 and IRC §1250 is excluded on a sale of the QOF interest after a 10-year hold when the investor makes the IRC §1400Z-2(c) election, for the part of the interest funded with deferred gain. If the fund sells the property, a separate election under Treas. Reg. §1.1400Z2(c)-1(b)(2)(ii) can exclude the gain for partnership or S-corporation funds, and a corporate fund gets no such election. Outside those conditions, depreciation recapture remains part of a taxable sale.
