What Is Boot in a 1031 Exchange

Boot is any value an investor receives in a Section 1031 exchange that is not like-kind real property. Common forms include cash boot, such as exchange proceeds not reinvested into the replacement property, and mortgage boot, which arises when debt relief on the relinquished property is not replaced with equal or greater debt or offsetting cash on the replacement property. Boot is taxable to the extent of recognized gain, even inside an otherwise valid exchange, which surprises investors who assume the entire transaction is automatically tax free.

Cash boot commonly appears when proceeds are used to pay non-qualifying closing costs, when prorated rent or security deposits are settled outside the exchange account, or when the investor simply chooses to take some proceeds out of the exchange. Mortgage boot appears when the replacement property carries less debt than the relinquished property and the investor does not add cash to make up the difference. Both forms of boot reduce the amount of gain that can be deferred, dollar for dollar.

To avoid boot entirely, an investor should acquire replacement property of equal or greater value than the relinquished property and carry equal or greater debt, or offset any reduction in debt with additional cash contributed to the purchase. Orange County investors trading down in value, or refinancing shortly before an exchange, should model boot exposure early. Recognized boot is taxed at federal capital gains rates, and California taxes the same gain as ordinary income, with combined state and federal exposure reaching well above 30 percent for investors in the highest brackets.