Net Boot

The netting rules come from two regulations, and Form 8824 puts them on one line.

Reg. section 1.1031(b)-1(c) offsets liabilities you take on against liabilities the other side takes from you. Reg. section 1.1031(d)-2, Example 2, adds that "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 cash or property you give does offset liabilities you are relieved of.

The Form 8824 instructions turn this into a line 15 worksheet: cash paid to you, plus the value of other property received, plus net liabilities assumed by the other party, all reduced, but not below zero, by exchange expenses.

The order matters. Debt relief is netted first against the debt you take on and the cash and other property you give; only the excess joins the cash and other property you receive, and expenses come off the combined total last.

• Debt relief offset by debt you take on: yes
• Debt relief offset by cash you add: yes
• Cash received offset by debt you take on: no
• Cash and debt relief reduced by exchange expenses: yes

In a hypothetical worksheet, two kinds of boot combine and closing costs come off the top.

Hypothetically, you exchange a building worth $1,000,000, subject to a $300,000 mortgage and with a $400,000 basis, for a building worth $900,000 subject to a $250,000 mortgage, plus $50,000 in cash. You pay $20,000 of exchange expenses. Net debt relief is $50,000, cash is $50,000, and net boot is $80,000.

Your realized gain is $580,000, so $80,000 is recognized and $500,000 is deferred. Had the replacement been worth $1,000,000 with a $350,000 loan, and the same $50,000 cash came to you, the new debt would erase the debt relief but not the cash: net boot would be $30,000. Run your own numbers with your CPA.

As a worksheet: cash received $50,000; debt relieved $300,000 less debt assumed $250,000, giving $50,000; subtotal $100,000; less exchange expenses $20,000; net boot $80,000. The replacement's basis is then $400,000, its $900,000 value less the $500,000 deferred.

It bites when owners count on a bigger loan or on closing-statement items to cut boot.

Because new debt never offsets cash received, refinancing up does not shelter cash taken out; see whether more debt offsets cash taken out. Only exchange expenses reduce net boot directly.

Publication 544 says prorated property taxes and rents, security deposits and repairs shown on a closing statement are not exchange expenses. Those items are covered in security deposits and prorations as boot and closing costs paid from exchange funds.

Exchange expenses help only to the extent there is boot to absorb them. Once line 15 reaches zero, leftover expenses move to line 18 and raise basis instead.