When completing a 1031 exchange, the primary goal is to defer capital gains tax by reinvesting all proceeds from your sale into like-kind property. However, if you don’t fully reinvest the proceeds or replace the debt from your relinquished property, you may trigger what’s known as “boot.”

What is Boot?

Boot is any non-like-kind property or additional value, such as cash or debt reduction, received by the exchanger during a 1031 exchange. This portion of the funds is taxable instead of tax-deferred.

How Does Boot Occur?

Boot occurs from the following scenarios:

1. Trading Down in Value
   • If the value of your replacement property is less than the value of the property you sold, the difference is taxable boot.
   • Example: Selling for $500,000 and buying for $400,000 results in a $100,000 boot.
2. Not Reinvesting All Proceeds (Cash Boot)
   • Keeping cash or failing to reinvest all net sales proceeds creates cash boot.
   • Example: Selling for $200,000 and reinvesting $175,000 results in a $25,000 cash boot.
3. Reducing Your Mortgage (Mortgage Boot)
   • If you assume less debt on the new property than you paid off on the old one and do not add cash to make up the difference, the reduction in debt is treated as boot. Even though no cash is received, the IRS sees this debt reduction as a financial gain.
   • Example: Paying off a $150,000 mortgage but only borrowing $100,000 on your new property results in a $50,000 mortgage boot.
4. Receiving Non-Like-Kind Property
   • Using exchange proceeds to acquire personal property (e.g., equipment, a primary residence) or to pay for non-allowable expenses (e.g., lender fees) also creates boot.
5. Constructive Receipt of Funds
   • All sale proceeds must go directly to a Qualified Intermediary (QI) to maintain the exchange’s tax-deferred status. If the investor or their agent takes possession of any funds before they reach the QI, those funds become taxable boot.

Rule of thumb:

To avoid boot and fully defer taxes, you must:

• Reinvest all net sales proceeds (after allowable closing costs) into one or more like-kind properties, and
• Take on equal or greater debt on your replacement property, or add cash to offset any debt reduction.

how to calculate boot:

It’s important that investors know how much boot they may have in their exchange before deciding whether keeping some proceeds is worth the tax liability.

Here’s a simple formula to calculate boot:

Boot = (Cash Received) + (Debt Reduction) + (Non-Like-Kind Property Value)

Examples of Boot in a 1031 Exchange

Below are scenarios that show when boot is and isn’t triggered in a 1031 exchange. Each scenario is accompanied by a table summarizing the transaction details.

No Boot

You exchange greater than or equal in both value and equity, so the exchange is fully tax-deferred.

	Relinquished Property	Replacement Property
Fair Market Value	$300,000	$400,000 (+$100k)
Debt	$100,000	$200,000 (+$100k)
Equity	$200,000	$200,000 (same)

Cash Boot

You exchange for a property of equal value with a larger loan and reduced equity. This will result in a $50,000 cash boot.

	Relinquished Property	Replacement Property
Fair Market Value	$300,000	$300,000 (same)
Debt	$100,000	$150,000 (+$50k)
Equity	$200,000	$150,000 (-$50k)

Mortgage Boot

You exchange down in property value, reinvest all net proceeds, and take out a smaller loan. This will result in a $50,000 mortgage boot.

	Relinquished Property	Replacement Property
FMV	$300,000	$250,000 (-$50k)
Debt	$100,000	$50,000 (-$50k)
Equity	$200,000	$200,000 (same)

Understanding how boot works in a 1031 exchange is key to maximizing your tax deferral. For guidance tailored to your specific tax liability, always consult your CPA or tax advisor. If you have questions about the 1031 exchange process, our team is here to help you navigate each step.

The information presented is for information purposes and is not intended as investment, legal, tax or compliance advice. Land 1031 does not offer or sell investments or provide investment, legal, or tax advice.

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