Boot in a 1031 Exchange: Cash, Mortgage Boot and Netting
Boot is the part of a 1031 exchange that isn’t like-kind real property, and it’s taxable: under IRC §1031(b) you recognize gain equal to the cash and the fair market value of other property you receive, capped at your realized gain. Debt you’re relieved of counts as cash (§1031(d); Reg. §1.1031(d)-2). The exchange still stands; you pay tax on the boot.
The two kinds of boot
Cash boot is money you receive or could have taken. That includes cash the QI hands back to you because the replacement cost less than your net proceeds, and cash released to you at closing.
Mortgage boot is net debt relief. If the buyer pays off a $400,000 loan on your old property and you only put a $300,000 loan on the new one, you have $100,000 of debt relief. The regulation treats the liabilities the other side assumes, or that your property is transferred subject to, “as money received by the taxpayer upon the exchange.”
Other property, such as a note from the buyer or furniture worth more than the incidental allowance, is boot at its fair market value. Personal property received with a replacement building is still boot even when it is small enough to be ignored for the QI safe harbor (Reg. §1.1031(k)-1(g)(7)(iii), Example 6).
The netting rules
Reg. §1.1031(d)-2, Example 2 sets out how the pieces offset each other. The regulation’s own words for the key sentence: cash received “is not offset by consideration given in the form of an assumption of liabilities,” but cash given “is offset against consideration received in the form of an assumption of liabilities.”
| You receive | You give | Do they offset? |
|---|---|---|
| Debt relief (old loan paid off) | New debt on the replacement | Yes |
| Debt relief | Cash you add | Yes |
| Cash | New debt on the replacement | No |
| Cash | Cash you add at the same closing | Yes, net cash |
Under the third row, borrowing more on the replacement property doesn’t cure cash you pulled out.
Worked example
These are round illustrative numbers. Closing costs are left out to keep the arithmetic clean; they come in below.
You sell a rental for $1,000,000. Your adjusted basis is $500,000, so your realized gain is $500,000. The buyer’s money pays off your $400,000 mortgage, and the QI holds the remaining $600,000.
| Scenario | Replacement price | New loan | QI funds used | Your added cash | Cash to you | Net debt relief | Boot |
|---|---|---|---|---|---|---|---|
| A. Buy down, take cash | $950,000 | $400,000 | $550,000 | $0 | $50,000 | $0 | $50,000 cash |
| B. Buy down, smaller loan | $950,000 | $350,000 | $600,000 | $0 | $0 | $50,000 | $50,000 mortgage |
| C. Buy up, add cash | $1,050,000 | $350,000 | $600,000 | $100,000 | $0 | $50,000 | $0 (cash added offsets debt relief) |
| D. Take cash, borrow more | $1,050,000 | $500,000 | $550,000 | $0 | $50,000 | none ($100,000 more debt) | $50,000 cash |
In A, B and D you recognize $50,000 of gain, the lesser of the $50,000 boot and the $500,000 realized gain. The remaining $450,000 is deferred. In C you recognize nothing.
In scenario D you bought a more expensive property and took on more debt, but the extra $100,000 of new debt does not offset the $50,000 of cash you received.
Basis of the replacement in scenario A
§1031(d) starts from your old basis, subtracts money received (including debt relief), and adds gain recognized. Following the layout in Reg. §1.1031(d)-2, Example 2:
- Old adjusted basis: $500,000
- Plus liabilities on the new property: $400,000 → $900,000
- Less money received: $50,000 cash + $400,000 debt relief = $450,000 → $450,000
- Plus gain recognized: $50,000 → $500,000
The new building cost $950,000 and has a $500,000 basis. The $450,000 difference equals the deferred gain.
Exchange expenses
Closing costs change the math in two places. On Form 8824, line 15 adds up cash received, the fair market value of other property received and net liabilities assumed by the other party, and then tells you to “reduce the sum of the above amounts (but not below zero) by any exchange expenses you incurred.” Expenses not used that way go on line 18, where they increase your basis side of the calculation and reduce realized gain.
On the safe-harbor side, paying transactional items out of exchange funds doesn’t break the QI arrangement. Reg. §1.1031(k)-1(g)(7)(ii) disregards items that “appear under local standards in the typical closing statements as the responsibility of a buyer or seller,” with commissions, prorated taxes, recording or transfer taxes and title fees as the regulation’s examples. Whether a specific charge on your settlement statement qualifies as an exchange expense is a question for your CPA.
How boot gain is taxed
Boot doesn’t create a new kind of income. The recognized gain has the character it would have had in a sale, and it’s reported through Form 8824 line 22 to Form 4797 or Schedule D.
For depreciated rental property, three layers can apply:
- Section 1245 ordinary income on cost-segregated components. Form 8824 line 21 computes it, and §1245(b)(4) can make it larger than the boot when the replacement property has less §1245 property than the property you sold. The Form 8824 instructions work an example where the seller receives $40,000 of cash boot, gives up $55,000 of §1245 property and gets none back, and reports $35,000 of §1245 ordinary income on line 21.
- Unrecaptured section 1250 gain, taxed at your ordinary rates but no more than 25% (§1(h)(1)(E)).
- The remaining long-term capital gain, at 0%, 15% or 20%.
How much of the recognized boot gain is unrecaptured §1250 gain? The IRS instructions don’t say directly for exchanges. The Schedule D worksheet looks at the smaller of depreciation or gain on Form 4797, and Form 8824 sends recognized gain to Form 4797 without addressing the worksheet. Reading §1(h)(6) together with the §1250 rules supports this result: unrecaptured §1250 gain is the smaller of the depreciation taken and the gain recognized, minus any §1250 ordinary recapture. On that reading, in scenario A, if you had taken more than $50,000 of depreciation, the whole $50,000 of boot would be unrecaptured §1250 gain. Treat that as an inference from the statute, not an IRS-stated rule, and confirm it with your CPA. See depreciation recapture for the rates.
Recognized gain on rental property is also generally net investment income subject to the 3.8% NIIT; deferred gain is not (Form 8960 instructions).
Ways boot shows up by accident
- Paying non-closing items, or anything that isn’t a transactional item, from exchange funds.
- A replacement loan sized smaller than the debt paid off, with no added cash.
- Earnest money or seller credits that end up paid to you.
- Leaving a little in the QI account and having it returned after the exchange.
To see what a given amount of boot costs, run your numbers through the capital gains tax calculator in exchange mode. The financing guide covers sizing the replacement loan.
Sources
Questions people ask
What is boot in a 1031 exchange?
Boot is anything you receive in the exchange that isn't like-kind real property: cash, debt you're relieved of that isn't replaced, or other property. Gain is recognized up to the amount of boot, but never more than your total realized gain.
Can I offset mortgage boot by adding cash?
Yes. Under Reg. 1.1031(d)-2, cash you pay into the exchange offsets debt you're relieved of. The reverse doesn't work: taking on new debt does not offset cash you receive.
Is boot taxed as capital gain?
Boot gain takes the character the gain would have had in a sale. On depreciated rental property, part or all of it can be unrecaptured section 1250 gain taxed at up to 25%, and cost-segregated personal property can produce ordinary income.