Key Takeaways
- Boot is any value received in a 1031 exchange that is not like-kind property. Even $1 of boot is taxable in the year of the exchange.
- Receiving $50,000 in mortgage relief without replacing it with equal or greater debt on the replacement property creates $50,000 of boot taxed at up to 23.8% federal, costing up to $11,900 before state taxes.
- Eliminate boot by trading into a replacement property with equal or greater value and equal or greater debt, and receiving zero cash at closing.
- Tool: Run your 1031 exchange numbers with the CalcMoney calculator →
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Boot Is the Taxable Exception Inside a Tax-Deferred Exchange
A 1031 exchange under IRC Section 1031 defers capital gains tax when an investor sells one investment property and reinvests the proceeds into like-kind property. Boot is every dollar of that transaction that does not qualify for deferral. The IRS taxes boot as recognized gain in the year of the exchange, even if the investor never sees the cash personally.
Boot comes in two forms. Cash boot is any cash the exchanger receives at or after closing, including leftover proceeds not reinvested. Mortgage boot, also called debt relief boot, arises when the debt on the replacement property is lower than the debt on the relinquished property.
The taxable amount is the lesser of the boot received or the total realized gain. An investor cannot owe more tax on boot than the total gain embedded in the property.
The Three-Step Formula for Calculating Boot
Calculating boot requires three inputs: the net sale price of the relinquished property, the adjusted basis of that property, and the terms of the replacement property acquisition.
Step 1. Calculate realized gain.
Realized Gain = Net Sale Price - Adjusted Basis
Net sale price equals the gross sale price minus selling costs (commissions, title fees, legal fees). Adjusted basis equals original purchase price plus capital improvements minus accumulated depreciation taken.
Step 2. Calculate total boot received.
Total Boot = Cash Boot + Mortgage Boot
Cash Boot = Net Sale Proceeds Not Reinvested into Replacement Property Mortgage Boot = Relinquished Property Debt Paid Off - Replacement Property Debt Assumed
If mortgage boot is negative (the investor takes on more debt), it offsets cash boot dollar for dollar.
Step 3. Calculate recognized gain.
Recognized Gain = Lesser of (Total Boot) or (Realized Gain)
Tax Owed = Recognized Gain x Applicable Capital Gains Rate
The applicable rate is 20% for long-term federal capital gains for high-income taxpayers, plus the 3.8% net investment income tax (NIIT) for single filers above $200,000 or joint filers above $250,000, plus any applicable state capital gains tax.
Worked Example 1: Cash Boot from a Partial Reinvestment
An investor sells a rental duplex for $900,000. Selling costs total $54,000, making the net sale price $846,000. The adjusted basis is $310,000, producing a realized gain of $536,000.
The investor pays off a $400,000 mortgage at closing. The qualified intermediary holds $446,000 in proceeds. The investor acquires a replacement property for $800,000, putting $346,000 down and financing $454,000. The remaining $100,000 stays in the investor's pocket.
Cash boot = $100,000. Mortgage boot = $400,000 paid off - $454,000 assumed = -$54,000. Negative mortgage boot offsets cash boot. Net boot = $100,000 - $54,000 = $46,000.
Recognized gain = $46,000 (lesser of $46,000 boot or $536,000 realized gain).
At the 20% federal long-term rate plus 3.8% NIIT, the federal tax bill on that $46,000 is $10,788. State taxes stack on top. The investor deferred $490,000 of gain but owed tax on $46,000 because they pulled $100,000 out.
Worked Example 2: Pure Mortgage Boot with No Cash Received
An investor sells a commercial warehouse for $1,200,000. Selling costs are $72,000, producing a net sale price of $1,128,000. Adjusted basis is $480,000. Realized gain is $648,000.
The relinquished property carried a $600,000 mortgage. The investor reinvests all $528,000 in net proceeds into a replacement property priced at $1,050,000, financing only $522,000 of the purchase price.
The investor received zero cash. But: Mortgage boot = $600,000 paid off - $522,000 assumed = $78,000. There is no negative cash boot to offset this. Total boot = $78,000.
Recognized gain = $78,000. Federal tax at 23.8% combined rate = $18,564.
The investor believed the exchange was fully tax-free because they touched no cash. The lower debt load on the replacement property created a $78,000 taxable event. The fix: finance at least $600,000 on the replacement property or acquire a higher-value property that requires more debt.
How Depreciation Recapture Interacts with Boot
Depreciation recapture under IRC Section 1250 adds another tax layer. Recaptured depreciation is taxed at your ordinary income rate, capped at 25%, not at the long-term capital gains rate. For a high earner in the 32% bracket or above, that means 25%.
If the recognized gain on boot includes embedded depreciation, the IRS taxes the depreciation portion first, at your ordinary rate up to the 25% cap. The remainder is taxed at the applicable long-term rate. Example 1 is a top-bracket investor (20% plus NIIT), so the 25% cap applies. If $20,000 of the $46,000 recognized gain represented accumulated depreciation, the tax calculation becomes:
$20,000 x 25% = $5,000 (depreciation recapture) $26,000 x 23.8% = $6,188 (capital gain + NIIT) Total federal tax = $11,188, not $10,788.
Depreciation recapture increases the effective rate on boot for investors who held property long enough to take substantial depreciation deductions.
How to Reduce or Eliminate Boot Before Closing
The simplest method is to acquire a replacement property with a purchase price equal to or greater than the net sale price of the relinquished property, and to carry equal or greater mortgage debt on that replacement property.
If some cash boot is unavoidable, investors sometimes use it to pay legitimate exchange expenses, including qualified intermediary fees and recording fees. Personal expenses, loan fees, and prepaid taxes do not reduce boot.
Adding a second replacement property is another option. IRC Section 1031 allows an exchanger to identify up to three replacement properties and close on more than one. Splitting the reinvestment across two properties can eliminate leftover cash and equalize debt loads.
Run Your Own Boot Calculation Before the Exchange Closes
The numbers above illustrate why estimating boot after a deal closes is too late. Tax liability crystallizes at closing. An exchanger who identifies the boot problem in the 45-day identification window still has time to select a different replacement property or adjust financing.
The CalcMoney 1031 exchange calculator lets you input your relinquished property sale price, adjusted basis, existing debt, and replacement property terms to calculate boot, recognized gain, and estimated federal tax owed in real time. Change the replacement property price or debt level and watch the tax liability update instantly.
Run the numbers before you identify your replacement property. A $50,000 shift in replacement property financing can eliminate a five-figure tax bill entirely.
Calculate your 1031 exchange boot and tax owed now →You Might Also Like
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Results are estimates for informational purposes only. Consult a licensed financial professional before making financial decisions.
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