In short
Boot rarely comes from taking cash on purpose. It comes from loan payoffs, deposit credits, repair credits and lender fees that shrink what reaches the intermediary.
Almost nobody is surprised by boot they chose. The surprise is boot that appears on a settlement statement nobody read as a tax document: a loan payoff, a credit to the buyer for tenant deposits, a repair allowance, a lender’s fee paid from exchange funds. Each one either counts as money received or shrinks the money that reaches the intermediary while leaving the reinvestment target where it was. This explainer shows where the lines come from and how to read the statement before closing.
Boot is measured at the end, not at closing
Section 1031(b) recognizes gain when you receive money or other property along with like-kind property, up to the amount of that money and property. Form 8824 does the measuring: line 15 adds cash received, the value of non-like-kind property received and net liabilities assumed by the other party, less exchange expenses; line 19 is your realized gain; line 20, recognized gain, is generally the smaller of the two (Instructions for Form 8824). Nothing on the statement is labelled boot. It has to be found.
The settlement statement has four kinds of lines
Transactional items. Reg. section 1.1031(k)-1(g)(7) lets exchange funds pay items 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)” without breaking the safe harbor, and exchange expenses reduce line 15. Commissions, title and escrow charges, transfer tax and the intermediary’s fee sit here. See which closing costs can be paid from exchange funds.
Prorations. The same paragraph disregards items “not included in the amount realized from the disposition of property (e.g., prorated rents).” Rent for the days you owned the building is rental income, not sale proceeds.
Credits that settle your own obligations. Tenant security deposits you hold and a credit for a repair you agreed to pay for are not costs of transferring the property. A credit for them lowers the wire to the intermediary without lowering the price you have to match, and it is not debt relief that new debt can offset. The cure is to move them off the statement and pay them from your own account; the details are in security deposits and rent prorations as boot.
Lender charges on the purchase. Points, origination fees and the lender’s policy exist because you borrowed, not because you acquired the property. Paying them from exchange funds spends exchange money on something that is not like-kind property; see loan fees and points as boot.
The loan payoff is the biggest line
The largest number on most statements is the mortgage payoff, and it is treated as money received under Reg. section 1.1031(b)-1(c) unless new debt or outside cash offsets it. Sellers who read “paid in full” as “nothing to replace” discover the opposite at tax time. The mechanism is in debt replacement in plain words.
Worked example: a hypothetical $1,000,000 sale
Round numbers. Price $1,000,000. Commission $50,000, title and escrow $8,000, transfer tax $4,000, so $62,000 of exchange expenses. Tenant deposits credited to the buyer $20,000. Loan payoff $300,000. The intermediary receives $618,000.
The price to match is $938,000, the sale price less the $62,000 of exchange expenses. Buy a replacement for $918,000 using the $618,000 and a new $300,000 loan, and the debt is covered but the price is $20,000 short, because the deposit credit left a hole that the loan cannot fill. That $20,000 is recognized gain. Bring $20,000 of your own cash to the replacement closing, buy at $938,000, and nothing is recognized. Let the intermediary pay $5,000 of lender points on top and $5,000 more is recognized. Run your own numbers with your CPA, and remember that recognized gain carries its own character; which part is taxed first is explained in is boot taxed as recapture or capital gain first.
Why it surprises people
Three reasons. The statement is prepared by an escrow or title officer whose job is to balance it, not to find boot. The regulation names only a few items, and the rest is inference from what the amount realized includes. And the loan payoff is so routine that it reads as a non-event. A settlement statement read a week early by your intermediary and your CPA, with every line marked “exchange funds” or “personal funds,” removes most of the surprise. The broader definition is in what is boot in a 1031 exchange, and planning around it in advanced boot tax planning.
What to do now
- Ask for the draft settlement statement a week before closing and send it to your intermediary and CPA with every credit line marked.
- Pay tenant deposits and any agreed repair allowance from your operating account by separate wire, and ask the buyer’s counsel to document it outside escrow.
- Decide how the loan payoff will be covered before you identify, and pay lender charges on the purchase from personal funds.
