WHAT IS BOOT IN A 1031 EXCHANGE

Boot is the term used for any value an investor receives in a one thousand thirty one exchange that is not like kind replacement real property held for investment or business use. It generally does not disqualify the exchange itself, but it is generally taxable to the extent it exists, even inside a transaction that otherwise defers the full gain. This is a general educational explanation of the concept. It is not tax, legal, or investment advice, and every investor should review the specific boot exposure on their own transaction with a tax advisor before closing.

Cash boot is the more straightforward of the two main categories. It generally includes any exchange proceeds not reinvested into the replacement property, including funds taken out at closing for any reason, no matter how small the amount is relative to the rest of the sale. If an investor sells a Las Vegas commercial property for a given amount and only reinvests a portion of the net proceeds into the replacement property, the unreinvested portion generally counts as cash boot and is generally taxable in the year of the exchange, separate from whatever portion of the gain remains deferred.

Mortgage boot is less intuitive and catches some investors off guard. It generally occurs when the debt on the replacement property is lower than the debt that was paid off on the relinquished property, even if every dollar of cash proceeds is reinvested. An investor paying off a mortgage on a Henderson retail building and purchasing an all cash industrial property in North Las Vegas generally has debt relief that counts as boot, since less debt on the new side is treated similarly to receiving cash, unless the investor adds enough new cash into the deal to offset it. Cash boot and mortgage boot generally stack together rather than offsetting each other, so both figures generally need to be calculated separately.

Boot can appear in forms that are not always obvious at first glance, which is one reason many investors review the closing statement carefully before signing.

• Cash taken out at or after closing rather than held in the exchange account
• Reduced debt on the replacement property compared to the relinquished property
• Non like kind property received as part of the deal, such as certain personal property
• Certain closing costs that do not qualify as standard exchange expenses

A common misconception is that any boot at all causes the entire exchange to fail. Generally that is not how it works. Boot generally carves out the taxable slice of an otherwise successful exchange rather than disqualifying the whole transaction, so an investor can still defer the majority of a gain even if a portion of it is taxed as boot. Because Nevada has no state income tax, boot in a Las Vegas exchange generally only triggers federal capital gains and depreciation recapture exposure rather than an added state tax layer, though the federal amount alone can still be meaningful on an appreciated property. This overview is educational only, and investors should confirm their specific boot calculation with a tax advisor before relying on it, ideally before the replacement property closing rather than after.

Because boot generally shows up in the numbers on the closing statement rather than in the property description itself, many investors generally review that statement line by line with a tax advisor before signing rather than after the transaction has already closed. A Las Vegas investor selling a leveraged rental property to purchase a lower debt replacement generally wants to see the debt relief calculation laid out clearly, comparing the payoff amount on the relinquished property against the new debt on the replacement property, since that comparison generally determines whether mortgage boot exists and how large it is. Closing costs also generally deserve a second look, since certain costs generally qualify as standard exchange expenses that reduce the amount of boot, while others generally do not and can inadvertently increase taxable exposure if they are paid out of exchange funds rather than separately. Investors generally find it easier to address a boot issue before the closing statement is finalized than after funds have already moved, since adjusting the purchase price, adding cash to the deal, or reallocating certain costs generally becomes far more difficult once the transaction has closed. This overview is educational only, and a final boot calculation should generally be confirmed with a tax advisor using the actual closing numbers rather than estimates made earlier in the process.

A brief conversation with a tax advisor early in the transaction, before a purchase agreement is signed on the replacement property, generally gives an investor the clearest picture of whether boot exposure exists and what options remain to reduce it before the numbers are locked in at closing.

This is especially true in transactions involving multiple properties, where boot calculated on one relinquished property can generally be offset differently than boot on another, and the aggregate figure across the full exchange is generally what matters most to the investor and the qualified intermediary preparing the final documentation.