What is boot in a 1031 exchange?

Boot is every dollar of consideration that is not like-kind real property

Three things count: cash that ends up with you rather than in the replacement property, property received that is not like-kind real estate, and debt you were relieved of and did not replace. The word never appears in the Code; it is shorthand for the "other property or money" that IRC §1031(b) describes.

The statute is short and it sets the ceiling: gain "shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property." Everything above that ceiling stays deferred into the replacement.

IPX1031 splits the same idea three ways, describing mortgage boot as "relief from debt on the Relinquished Property caused by the assumption of a mortgage, trust deed, contract, or an agreement to pay other debt that is not replaced."

• Cash boot: money taken at the closing table, money drawn from escrow before your intermediary receives it, or whatever sits unspent in the exchange account on day 180.
• Other-property boot: a note from your buyer, stock, a partnership interest, or anything else received that is not real property held for investment.
• Mortgage boot: the excess of the debt you shed over the debt you took on, measured across the whole exchange rather than loan by loan.

Debt relief is treated as money received although nobody writes you a cheque

Treas. Reg. §1.1031(b)-1(c) is explicit: "consideration received in the form of an assumption of liabilities (or a transfer subject to a liability) is to be treated as other property or money for the purposes of section 1031(b)." The closing sentence of section 1031(d) repeats it for basis.

So an owner who walks away from a $400,000 loan and buys a replacement carrying a $250,000 loan has received $150,000, even though every dollar of cash equity went into the purchase. The benefit is the disappearance of an obligation, and the tax law prices it at face value.

That is why the target you have to hit is measured against the whole sale, not against the cheque from escrow. Do I reinvest the whole sale price or just my gain sets out the three tests.

The taxable amount is the smaller of net boot and realized gain, and a loss stays locked in

Form 8824 applies the ceiling mechanically. Line 15 totals the boot, line 19 is your realized gain, and line 20 tells you to "enter the smaller of line 15 or line 19, but not less than zero" (Instructions for Form 8824).

An owner with a very low basis therefore pays on the whole of the boot. An owner whose realized gain is only $40,000 pays on $40,000 even after keeping $90,000, because the rest is a return of capital rather than gain.

Section 1031(c) refuses the mirror image: "no loss from the exchange shall be recognized." Taking boot cannot convert a loss into a deduction, which is the argument on should I exchange if I am selling at a loss.

Netting runs one way: cash you add cancels debt relief, new debt never cancels cash

Example 2 of Treas. Reg. §1.1031(d)-2 states the asymmetry in a single sentence: "consideration received in the form of cash or other property is not offset by consideration given in the form of an assumption of liabilities," while "consideration given in the form of cash or other property is offset against consideration received in the form of an assumption of liabilities."

The example's two sides show both halves. E transfers property carrying a $150,000 mortgage, takes on an $80,000 mortgage and pays $40,000 in cash, and is left with $30,000 of boot. D, on the other side, keeps $40,000 of cash and is taxed on all of it although his mortgage went from $80,000 to $150,000.

Does more debt offset the cash I take out works that second half through in current dollars, and do I have to replace my mortgage or can I add cash works through the first.

Commissions and other exchange expenses come off the boot before tax is figured

The line 15 instructions direct you to "reduce the sum of the above amounts (but not below zero) by any exchange expenses you incurred." Expenses not used there are added to your basis on line 18 instead, so the deduction is taken once, not twice.

IRS Publication 544 shows the arithmetic with its own numbers: an exchanger receiving $10,000 of cash and $30,000 of mortgage relief has $40,000 of boot, less $5,000 of exchange expenses paid, for $35,000 of recognized gain.

Only items that genuinely belong on the settlement statement qualify. Treas. Reg. §1.1031(k)-1(g)(7)(ii) describes them as costs that "appear under local standards in the typical closing statements as the responsibility of a buyer or seller (e.g., commissions, prorated taxes, recording or transfer taxes, and title company fees)." Which closing costs can be paid from exchange funds sorts the borderline ones.

A $1,000,000 sale where $85,000 of boot appears from two directions at once

Hypothetical with round numbers. You sell a rental for $1,000,000, the buyer's funds clear your $350,000 mortgage, $60,000 of commissions and title charges come off the settlement statement, and $590,000 reaches your qualified intermediary.

You then buy for $855,000 using a new $315,000 loan and $540,000 from the exchange account, and the remaining $50,000 comes back to you when the exchange closes. Cash boot is that $50,000; mortgage boot is $350,000 less $315,000, or $35,000.

Net boot is $85,000, against which the $60,000 of exchange expenses may be applied once under the line 15 rule. Whatever is left is recognized this year, and the rest of the gain rides into the replacement's basis.

Where the number lands on the return, and which rate reaches it first

The boot total is line 15 of Form 8824, the recognized gain is line 20, ordinary income under the recapture rules is line 21, and the balance carries to Form 4797 or Schedule D by way of line 22. How to fill out Form 8824 walks the sequence.

The character of that recognized gain is not yours to choose. Recapture is taken out before anything is treated as long-term capital gain, which is why modest boot on a long-held rental is often taxed at a higher rate than the owner expected; is boot taxed as recapture or capital gain first has the ordering.

Confirm your own figures with your CPA or attorney before you sign the closing statement, because boot is fixed by the documents and cannot be unwound afterwards.