Boot in a 1031 Exchange: Cash Boot, Mortgage Boot, and How the Netting Rules Work

The Short Answer

In a 1031 exchange, boot is any value you receive that is not like-kind real property. It comes in three common forms: cash that comes back to you, net relief from mortgage debt, and non-qualifying property conveyed alongside the real estate. Receiving boot does not disqualify an exchange. It simply means that part of the gain is generally recognized and taxed in the year of the exchange, while the rest remains deferred.

Boot is the most frequent reason an exchange that was meant to be fully tax-deferred ends up producing a tax bill. It is rarely the result of a dramatic mistake. More often it comes from a replacement loan that is a little smaller than the old one, a few prorations on the settlement statement, or leftover proceeds that were never redeployed. Understanding how boot is measured is the most practical way to see it coming. (For a one-paragraph definition, see the glossary entry on boot.)

The Three Forms of Boot

Cash boot. Any money or cash-equivalent value you receive. The obvious example is exchange proceeds the qualified intermediary returns to you because they were not needed to purchase replacement property. Less obvious examples include sale proceeds used to pay non-transactional items at closing, such as rent prorations or security deposits credited to the buyer, or lender-related charges paid out of exchange funds. Our 1031 exchange cost guide lists which closing costs exchange funds can generally pay without creating boot.

Mortgage boot. Also called debt relief. When the mortgage paid off on the property you sell is larger than the debt you take on with the replacement property, the tax code generally treats the difference as though you had received it in cash. You never see the money, which is why mortgage boot surprises so many investors.

Other property. Since 2018, only real property qualifies for like-kind treatment. Personal property received in an exchange, such as furniture, appliances, or equipment conveyed with a replacement building, is generally treated as boot to the extent of its fair market value. A seller-financed note received on the sale of the relinquished property is another form of non-like-kind value that requires careful structuring with your qualified intermediary and CPA.

How Much Gain Is Actually Taxed

The rule under Section 1031(b) is straightforward in principle: gain is generally recognized in an amount equal to the lesser of the boot received or the gain realized on the sale. Two consequences follow.

• Boot is not the same as tax. If you receive $100,000 of net boot on a sale that produced $600,000 of realized gain, roughly $100,000 of gain is generally recognized. That gain is then taxed at whatever rates apply to it.
• Boot cannot create gain that does not exist. If the boot exceeds the total realized gain, the recognized amount is capped at the realized gain. Losses, on the other hand, are not recognized in a like-kind exchange.

The character of the recognized gain matters as much as the amount. On depreciated real estate, recognized gain is often treated as coming first from the portion attributable to prior depreciation, which can be taxed at a maximum federal rate of 25 percent as unrecaptured Section 1250 gain, rather than at the long-term capital gains rate. Our depreciation recapture calculator shows how that portion is estimated. Recognized boot may also be subject to the 3.8 percent net investment income tax for taxpayers above the income thresholds. The exact characterization depends on the property history and should be confirmed by your CPA.

The Netting Rules: Which Offsets Work and Which Do Not

Boot is measured on a net basis, but the netting is not symmetrical. The Treasury regulations allow some offsets and not others:

The third row is the one that catches investors. Bringing cash to the table can cure a shortfall in debt. Borrowing more cannot cure a shortfall in reinvested cash. If proceeds come back to you, they are generally boot even if the replacement loan is much larger than the old one.

Three Scenarios on the Same Sale

The following illustrations are hypothetical, rounded, and ignore closing costs for clarity. Assume an investor (and accredited investor) sells a rental property for $1,000,000. The adjusted basis is $400,000, so the realized gain is $600,000. A $300,000 mortgage is paid off at closing, and $700,000 of net proceeds goes to the qualified intermediary.

Scenario 1: Trading down. The investor buys a $900,000 replacement property with a $250,000 loan. The purchase requires $650,000 of equity, so $50,000 of exchange funds is left over and returned. Debt fell from $300,000 to $250,000, a $50,000 reduction.

• Cash boot: $50,000
• Mortgage boot: $50,000
• Total boot: $100,000, so roughly $100,000 of gain is generally recognized and $500,000 is deferred

Notice that the total boot equals the $100,000 difference between the sale price and the replacement price. That is not a coincidence. It is why the common guideline is to buy replacement property of equal or greater value, reinvest all net proceeds, and replace the debt that was paid off.

Scenario 2: Curing mortgage boot with cash. The investor buys a $1,000,000 replacement property with a $200,000 loan, using all $700,000 of exchange funds plus $100,000 of personal cash. Debt fell by $100,000, but the additional $100,000 contributed offsets that debt relief. Net boot is zero, and the full $600,000 gain is generally deferred.

Scenario 3: More debt does not cure cash boot. The investor buys a $1,100,000 replacement property with a $450,000 loan. The purchase requires only $650,000 of equity, so $50,000 of exchange funds is returned. Even though the new debt is $150,000 larger than the old debt, that increase does not offset the $50,000 of cash received. Roughly $50,000 of gain is generally recognized.

How Boot Affects the Basis of the Replacement Property

Deferred gain does not disappear. It is carried into the replacement property through a lower basis. In general terms, the basis of the replacement property equals the adjusted basis of the relinquished property, plus any additional cash paid and new debt assumed, plus gain recognized, minus cash received and debt relieved.

In Scenario 1, that works out to $400,000 + $250,000 + $100,000 − $300,000 − $50,000 = $400,000. A simpler cross-check gives the same figure: the $900,000 purchase price minus the $500,000 of deferred gain. That lower basis reduces future depreciation deductions and preserves the deferred gain for a later sale. The 1031 vs. paying the tax comparison discusses that trade-off in more detail.

When Boot Is Received Matters Too

Exchange funds held by a qualified intermediary are not freely available. Under the safe harbor rules, exchange agreements generally restrict access to funds until the 45-day identification period ends without any property identified, until all identified replacement properties have been acquired, or until the 180-day exchange period expires. Leftover cash typically comes back only at one of those points.

That timing can matter for an exchange that begins late in one tax year and ends in the next. In some circumstances, boot received in the following year may be reportable in that later year. Whether that treatment applies depends on the facts and the exchange documents, so it is a question for your CPA before the sale closes rather than after.

Planning Points Worth Discussing Before the Sale

• Model the debt, not just the price. Many unintended boot problems come from a replacement loan that is smaller than the loan being paid off. Knowing the payoff figure early allows time to plan either matching financing or additional cash.
• Review the settlement statements before closing. Prorations, deposits, and lender charges paid from exchange funds are a common and avoidable source of cash boot.
• Consider replacement options that carry debt. Some investors use Delaware Statutory Trust interests as all or part of their replacement property. DST offerings often include pre-arranged, non-recourse financing, which some exchangers use to help match the debt on the relinquished property. DSTs carry their own risks, fees, and illiquidity, and are not appropriate for every investor.
• Decide whether a partial exchange is intentional. Taking some cash out is legal and sometimes sensible. The point is to make that choice deliberately, with an estimate of the resulting tax, rather than discover it on next year’s return.