What Is Boot in a 1031 Exchange

Boot is the term used to describe any value received in a Section 1031 exchange that is not like kind real property, and it is the primary source of unexpected taxable gain for investors who otherwise structure a compliant exchange. There are two main categories of boot that investors in Baltimore, MD should understand. Cash boot occurs when an investor receives cash or its equivalent, including any exchange proceeds that are not fully reinvested into replacement property, funds released early from the qualified escrow, or a purchase price adjustment paid directly to the investor rather than applied to the replacement property. Mortgage boot, sometimes called debt relief boot, occurs when the debt paid off on the relinquished property exceeds the debt placed on the replacement property, meaning the investor's liabilities decreased as part of the transaction. Because a decrease in mortgage debt is treated similarly to receiving cash, an investor who trades down in loan balance without contributing additional cash to offset that reduction will generally recognize boot equal to the net debt relief. To avoid boot entirely, the general rule of thumb is that the replacement property value must equal or exceed the relinquished property value, and the replacement property debt must equal or exceed the relinquished property debt, unless the investor contributes additional cash to make up any shortfall. It is worth noting that since the Tax Cuts and Jobs Act took effect for exchanges completed after December thirty first, two thousand seventeen, personal property, such as fixtures, equipment, and furnishings that were once eligible for their own like kind exchange treatment, no longer qualifies under Section 1031 at all. Any personal property value bundled into a real estate transaction is now treated as boot by default rather than as a separately exchangeable asset. Boot does not disqualify the entire exchange. Rather, gain is recognized only to the extent of the boot received, up to the total realized gain on the transaction, while the remaining gain continues to be deferred. Recognized boot is reported on Internal Revenue Service Form eight thousand eight hundred twenty four and is subject to federal capital gains tax and, for investors in Baltimore, MD, Maryland state income tax at the applicable graduated rate plus the county piggyback local income tax assessed by the county or municipality where the investor resides. Because Maryland also requires withholding at closing on real property sales, coordinating boot calculations with the settlement agent and qualified intermediary before the sale closes helps avoid surprises. We help investors run the numbers before an exchange is structured so replacement property value and debt levels are calibrated to minimize or eliminate boot exposure.