What Is Boot in a 1031 Exchange

Boot is any value an investor receives during a 1031 exchange that is not like-kind real property. Boot is taxable to the extent of the realized gain, even when the rest of the transaction otherwise qualifies for deferral under Section 1031. The two most common forms of boot are cash boot and mortgage boot.

Cash Boot

Cash boot includes leftover exchange funds that are not reinvested into replacement property, funds withdrawn from the qualified intermediary account, and any cash the investor receives at closing that is not applied toward the acquisition of replacement property.

Mortgage Boot

Mortgage boot, sometimes called debt relief, arises when the debt on the replacement property is lower than the debt that was on the relinquished property. To fully defer gain, an investor generally must replace both the equity and the debt of the relinquished property, or offset a reduction in debt with additional cash brought into the transaction.

Other Forms of Boot

Boot can also arise from non-qualified use property, or from personal property received alongside real property in a transaction, since the Tax Cuts and Jobs Act limited Section 1031 to real property for exchanges completed after December 31, 2017.

Calculating Boot

Consider the following example, used only to illustrate the calculation and not tied to any specific transaction. An investor sells a District of Columbia property valued at $2,000,000 with $500,000 of debt, producing $1,500,000 of equity. The investor then acquires replacement property valued at $1,800,000 with $300,000 of debt, contributing $1,500,000 of equity. In this scenario, the replacement property carries $200,000 less debt than the relinquished property, which may be treated as mortgage boot unless offset with additional cash invested in the replacement property.

Reducing or Eliminating Boot

• Reinvest all net sale proceeds into replacement property
• Acquire replacement property with debt equal to or greater than the relinquished property debt
• Add cash to the replacement property purchase to offset any reduction in debt
• Avoid withdrawing cash from the qualified intermediary account during the exchange period

Exchange Expenses and Boot

Certain transaction costs reduce boot and certain costs do not. Typical exchange expenses, such as qualified intermediary fees, title insurance premiums, and standard closing costs, can generally be paid from exchange proceeds without creating boot. Costs that are not considered exchange expenses under Treasury guidance, including loan fees on financing for the investor rather than the property, or prorated rent and security deposits treated as separate from the sale price, may be treated differently and should be reviewed with a tax advisor before the closing statement is finalized.

Boot and District of Columbia Tax Treatment

Any boot recognized in an exchange involving a District of Columbia resident is taxed twice, once under the federal capital gains rules and again under the District individual income tax. The District does not provide a separate, lower rate for capital gains. Instead, recognized gain is added to ordinary income and taxed under the District graduated brackets, which reach 10.75 percent for taxable income above $1,000,000. Investors planning an exchange that may generate some boot should model both layers of tax rather than the federal figure alone.

Boot Created by Unequal Replacement Timing

Boot can also arise when an investor closes on a replacement property before all relinquished property sale proceeds have been received, or when a portion of the identified replacement portfolio is never acquired. In a multi-property acquisition, common in the DC metro market when an investor diversifies across a single tenant retail asset and a multifamily property, unused funds remaining in the qualified intermediary account after the last permitted closing are returned to the investor and treated as boot at that time.

Reviewing the Closing Statement for Boot Exposure

A careful review of the closing statement for both the relinquished and replacement property is the most reliable way to catch boot before it becomes a surprise on the tax return. Line items to review include the final sale price compared to the identified replacement property price, the debt paid off at the relinquished property closing compared to the debt placed on the replacement property, and any funds disbursed directly to the investor rather than applied to the acquisition. We recommend investors ask their qualified intermediary and tax advisor to review both closing statements side by side before either closing is finalized.

Frequently Asked Questions

Is boot always cash?

No. Boot can include debt relief, non-like-kind property, or any value received by the investor that is not real property held for investment or business use.

Does receiving a small amount of boot disqualify the entire exchange?

No. Boot does not disqualify an exchange. It becomes taxable to the extent of the realized gain, while the remaining value continues to defer under Section 1031.

Can an investor offset mortgage boot with cash?

Yes. Adding cash to the replacement property acquisition can offset a reduction in debt, which helps preserve full deferral even when the replacement property carries less financing than the relinquished property.

This article provides educational content only. It does not constitute tax, legal, or investment advice. Section 1031 defers federal income tax on qualifying real property and does not remove Washington DC transfer or recordation tax obligations. Consult a qualified tax advisor or attorney before acting on any exchange timeline.