Boot netting rules: can cash I add offset mortgage boot, and can mortgage relief offset cash boot?

The regulation states the one-way rule in a single parenthetical sentence

In Example 2 of Reg. section 1.1031(d)-2, one party is relieved of $150,000 of debt, takes on $80,000 and pays $40,000 cash; only $30,000 is boot. The regulation explains: 'Although consideration received in the form of cash or other property is not offset by consideration given in the form of an assumption of liabilities or a receipt of property subject to a liability, consideration given in the form of cash or other property is offset against consideration received in the form of an assumption of liabilities or a transfer of property subject to a liability.'

The other party in that example received $40,000 cash while taking on $70,000 more debt than it shed, and still recognized $40,000. Why the asymmetry exists, and the variations exchangers try around it, are on whether more debt offsets the cash taken out.

Form 8824 line 15 runs the netting in three steps

The Form 8824 instructions build line 15 from three pieces, then cap the result with your gain.

• Cash and other non-like-kind property you received, counted in full.
• Net liabilities assumed by the other party: the excess of debt you were relieved of over the total of debt you took on, cash you paid and non-like-kind property you gave up. If that is negative, it is zero.
• The sum, reduced 'but not below zero' by exchange expenses such as commissions and title fees.
• Line 20 then recognizes the smaller of line 15 and your realized gain on line 19.

Cash received early and paid back later still counts as boot

The deferred exchange regulation tests timing as well as amounts. In Example 2 of Reg. section 1.1031(k)-1(j)(3), the taxpayer receives $10,000 when the relinquished property closes, then pays $10,000 toward the replacement months later. The $10,000 received is still 'money or other property' and $10,000 of gain is recognized; the later payment only raises basis.

With several relinquished or replacement properties, debt is pooled across the exchange. Publication 544 says 'all liabilities assumed as part of the exchange are offset against all liabilities of which you are relieved', so a new loan on one replacement can cover a payoff on a different relinquished property.

Worked example: the same sale, three ways to buy, three line 15 results

Hypothetical, round numbers; run your own numbers with your CPA. You sell a rental for $1,000,000, a $400,000 mortgage is paid off, and $600,000 goes to your intermediary. Realized gain is well above $100,000.

Buy A: a $900,000 replacement with all $600,000 of exchange cash, a $250,000 loan and $50,000 of your own money. Debt relief of $400,000 less $250,000 of new debt and $50,000 paid leaves $100,000 of net liabilities, so line 15 is $100,000 of mortgage boot. Adding $100,000 more of your own cash, or borrowing it, would have brought it to zero.

Buy B: a $1,000,000 replacement with a $500,000 loan and $500,000 of exchange cash, with $100,000 returned to you after day 180. Net liabilities are zero because new debt exceeds debt relief, but the $100,000 cash received stands alone. Line 15 is $100,000, and the extra $100,000 of debt does nothing for it.

Buy C: as B, but $30,000 of commissions and title fees were paid from the sale proceeds. Line 15 is $100,000 less $30,000, or $70,000. Taxable boot is taxed first at up to 25% on the depreciation layer; see whether boot is taxed as recapture first.

Plan the purchase so the cash side ends at zero, then let debt and added cash cover the loan you shed

In practice the rule gives a simple order of work. First, make sure every dollar the intermediary holds is spent on replacement property, because nothing later can cure cash left over. Second, cover the debt you were relieved of with any mix of new loans, seller notes and your own cash.

When an odd amount would be left with the intermediary, a Delaware Statutory Trust interest named on your identification list can absorb it, and the trust's non-recourse loan allocated to you counts as debt taken on; see leftover cash after the exchange and traditional DSTs. Trust interests are illiquid and carry sponsor, lender and tenant risk.