What Is Boot in a 1031 Exchange

Cash boot is the simplest form: any exchange proceeds not reinvested into the replacement property, whether it lands in the investor's pocket directly or is used for something the IRS does not treat as a qualifying exchange expense. Paying off a personal credit card with exchange funds, or taking a distribution before the exchange closes, both create cash boot. Even leftover funds sitting with the qualified intermediary after closing, released back to the investor because the replacement property cost less than the relinquished property sold for, count as cash boot.

Mortgage boot, sometimes called debt-relief boot, is less intuitive. If the debt paid off on the relinquished property is larger than the debt taken on the replacement property, the difference is treated as boot, even if the investor never touches a dollar of cash. A Kenner investor who pays off a 400,000 dollar note on a sale and only carries a 250,000 dollar note on the replacement building has 150,000 dollars of debt-relief boot, taxable the same as if that amount had been handed over in cash.

Debt relief boot can be offset by adding new cash into the deal, but it generally cannot be offset by increasing debt on a different property inside the same exchange, and it cannot be netted against cash boot received in the opposite direction without care.

When an exchange involves more than one relinquished or replacement property, the IRS allows some netting of debt relief against new debt taken on, but cash boot received on one property generally cannot be offset by extra cash invested in another. Exchanges involving several parcels, common with investors consolidating scattered rental property across Jefferson and Orleans Parish into one larger asset, need this netting worked out carefully before closing, not reconstructed afterward from closing statements.

The two rules that keep an exchange boot-free are straightforward on paper: the replacement property must be equal to or greater in value than the relinquished property, and the debt on the replacement property must be equal to or greater than the debt paid off on the relinquished property, unless the shortfall is covered with new cash. Trading down in either price or leverage, even slightly, creates some boot. It does not disqualify the rest of the exchange, but it does mean a portion of the deferred gain becomes taxable in the year of the sale.

Southeast Louisiana closings carry a few line items that can create boot by accident if nobody flags them. Prepaid flood and wind pool premiums on the relinquished property, refunded at closing, are proceeds that need to flow through the exchange rather than being paid directly to the seller outside of it. Likewise, a seller credit negotiated to cover a buyer's closing costs on the replacement property can shrink the amount of exchange funds actually applied to the purchase price, which shows up later as unintended cash boot if the closing statement is not reviewed against the exchange requirements before signing.

Certain transactional costs, sometimes called exchange expenses, can be paid directly out of exchange proceeds without creating boot, including the qualified intermediary's fee, standard title and recording charges, and the closing attorney's fee. Costs unrelated to the transaction itself, such as a loan application fee for financing unrelated to the exchange or a personal expense routed through closing, do not qualify as exchange expenses and can create boot if paid from exchange funds.