What Is "Boot"? Do I Have to Buy a More Expensive Property?

“I sold for $1.5 million. Can I buy something for $1.2 million and take the rest out?” Yes, but the part you take out is taxable. In a 1031 exchange, that part is called “boot.” Understanding boot tells you how much of your tax the exchange will actually defer.

The “Equal or Up” Principle

To defer all the tax, you generally must do both:

1. Buy replacement property priced at least as much as the old property’s net sale price (the price minus selling expenses);
2. Reinvest all of the net cash from the sale.

Falling short does not make the exchange fail. You simply pay tax on the shortfall. This is called a “partial exchange.”

Two Common Types of Boot

Cash boot is cash you actually receive during the exchange, or sale proceeds used to pay expenses unrelated to the exchange.

Mortgage boot arises when the old mortgage is paid off, the new mortgage is smaller, and you don’t make up the difference in cash. The reduction in debt is treated as if you received money.

Two important rules:

• Additional cash you put in can offset a reduction in debt;
• But taking on more new debt cannot offset cash you take out.

A Complete Example

You sell a rental building:

• Sale price: $1,500,000
• Old mortgage: $500,000
• Selling expenses (commission, transfer taxes, legal fees and so on): $90,000
• Net sale price: $1,500,000 − $90,000 = $1,410,000
• Cash to the intermediary: $1,500,000 − $500,000 − $90,000 = $910,000

Taxable boot is capped at the gain realized in the exchange. This example is simplified; have your accountant do the actual calculation.

Which Costs Can Be Paid From Exchange Funds?

Generally acceptable:

• Broker commissions;
• Transfer taxes;
• Legal, title and recording fees directly related to the sale and purchase;
• Intermediary fees.

Items that may create boot and deserve attention:

• Closing credits for tenant security deposits and prepaid rent;
• Apportionment of routine charges such as property taxes and water;
• Loan fees on the new mortgage, repair costs and similar items.

It is best to have your attorney and accountant review the closing statement together before closing.

Can I Refinance First and Pull Cash Out?

A large cash-out refinance right before a 1031 sale may be viewed by the IRS as a disguised withdrawal from the exchange. By contrast, refinancing after you acquire the replacement property usually carries less risk. Timing and purpose both matter, so ask before you act.

Attorney’s Insight

“Equal or up” sounds simple. What actually trips people up are the details of debt and the closing statement. Our advice:

• Before listing, calculate your “net sale price” and “cash to reinvest.” Those two numbers determine what price range to look for and how much financing you’ll need;
• If you want some cash out, make it a deliberate choice. A partial exchange is perfectly legal. The point is to know the tax in advance, not to discover it after closing;
• Read every line of the closing statement. Small items such as security deposits and rent prorations can create boot if handled poorly.

Attorney’s perspective

Before you sign, we work out how much you need to reinvest and how much debt you need to take on to avoid tax on boot.

For advice about your own situation, call +1 718-218-5805 or schedule a consultation. We meet clients in Flushing and Manhattan, in English or Chinese.

Series overview

This article is for general information only and is not legal advice. Reading it does not create an attorney-client relationship. For advice about your situation, please contact us.

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