Commercial Real Estate
1031 Exchange

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There is no mention of “boot “in the IRS Code so investors frequently ask what boot refers to in a 1031 exchange. What exactly is 1031 exchange boot and how does it relate to capital gain tax?

In 1031 exchange boot refers to “in addition or profit”. In a 1031 exchange, “in addition or profit” is anything of value received by the investor which is not deemed “like kind” in the exchange. This can include personal property boot, cash boot and mortgage boot.

The most common forms of 1031 exchange boot are “mortgage boot” and “cash boot”. In addition, proceeds from real property used to acquire personal property can create “personal property boot”. Boot occurs when the value of the replacement property is less than the property that was sold less selling expenses.

Mortgage boot occurs if the debt on the relinquished property (the property being sold) is not replaced with an equal or greater amount of debt, or with non 1031 cash. For example, if the relinquished property had a $100,000.00 mortgage, and the replacement property has a $90,000.00 mortgage, the investor will pay capital gain tax on $10,000.00 unless they add $10,000 in non 1031 cash to their exchange.

Cash boot is anything received by the investor in the form of money or other property. An example is an investor electing to receive a portion of cash from the qualified intermediary at closing. This cash is subject to capital gain tax.

An additional example would be if the seller assists in the sale of relinquished property by providing financing. If not handled properly the seller would pay capital gain tax on the principal payments and ordinary income tax on the interest portion received.

Personal property boot may occur when personal property is included in the sale of the relinquished property. To avoid this make sure any personal property is explicitly excluded from the sales agreement and handled in a separate sales agreement.

Please consult with your tax advisor and or attorney when considering a 1031 exchange and be sure to ask about 1031 exchange boot, personal property boot, cash boot and mortgage boot.