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Boot and the 1031 Exchange
Investors frequently ask what boot refers to in a 1031 exchange. There is no mention of boot in the IRS Code so what exactly is it?
As used in 1031 exchanges the archaic definition of the word boot is being used which is “in addition or profit” not what you do with your computer on startup or wear on your feet.
In a 1031 exchange the “in addition or profit” is anything of value received by the investor which is not deemed “like kind” in the exchange.
The most common forms of Boot are Mortgage Boot and Cash Boot. In addition, proceeds from real property used to acquire personal property can create “Personal Property Boot”.
Mortgage Boot occurs if the debt on the relinquished property (the property they are selling) is not replaced with an equal or greater amount of debt, or with cash from 1031 funds on the replacement property.
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 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.
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 gains 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.