What Is Boot in a 1031 Exchange and How Does It Affect Taxes?

A 1031 exchange allows real estate investors to defer capital gains taxes by reinvesting proceeds from a sold property into another like-kind property. However, if part of the transaction includes non-like-kind property or cash, it can trigger taxable income known as “boot.” Understanding how boot works helps investors structure transactions to maximize tax deferral benefits and avoid unexpected liabilities.

When Boot Arises

Boot occurs when an investor receives something of value that does not qualify for tax deferral in a 1031 exchange. This typically happens when the replacement property is worth less than the relinquished property, leaving excess proceeds that are not reinvested. Any leftover amount is considered boot and becomes taxable.

Another common scenario involves additional parties or intermediaries facilitating the exchange. If an investor receives funds or benefits outside of the direct property swap—such as prorated rent, security deposits, or credits for repairs—the IRS classifies these amounts as boot, even if the investor never physically receives the cash.

Timing also plays a role. The IRS requires investors to identify a replacement property within 45 days and complete the exchange within 180 days. Missing these deadlines may disqualify the exchange, and any proceeds held by a qualified intermediary could be distributed to the investor, triggering taxable boot.

Types of Boot

Boot in a 1031 exchange takes different forms, each with tax implications. The most common types include cash, debt relief, and non-like-kind property.

Cash

Cash boot arises when an investor receives money from the exchange instead of reinvesting the full proceeds into a replacement property. This can happen if the new property costs less than the one being sold or if the investor withdraws a portion of the sale proceeds. The IRS treats any cash received as taxable gain, subject to capital gains tax rates ranging from 0% to 20%, depending on the investor’s income.

For example, if an investor sells a property for $500,000 and buys a replacement for $450,000, the $50,000 difference is considered cash boot and taxed as a capital gain. Earnest money or other cash distributions received during the exchange process may also be classified as boot. To avoid this, all proceeds should be handled by a qualified intermediary and fully reinvested into the replacement property.

Debt

Debt boot occurs when the mortgage or other liabilities on the replacement property are lower than those on the relinquished property. The IRS requires investors to maintain or increase their level of debt to fully defer taxes. If the new property has a lower mortgage balance, the difference is considered boot and is taxable.

For instance, if an investor sells a property with a $300,000 mortgage and acquires a replacement with a $250,000 mortgage, the $50,000 reduction in debt is treated as boot. Even if no cash is received, the IRS views the debt reduction as a financial benefit and taxes it accordingly. One way to offset debt boot is by adding additional cash to the exchange to cover the shortfall.

Other Non-Like-Kind Property

Non-like-kind property boot includes any assets received in the exchange that do not qualify as real estate under IRS rules. This can include personal property, such as furniture or equipment, as well as intangible assets like goodwill in a business-related transaction. If an investor receives these items as part of the exchange, their fair market value is considered taxable income.

For example, if an investor trades a commercial building for another but also receives office furniture valued at $10,000, that amount is treated as boot and taxed. Similarly, if a seller provides credits for repairs or improvements instead of adjusting the purchase price, these credits may be considered boot. To avoid this, investors should structure transactions so that all value is allocated to real estate rather than non-like-kind assets.

Calculating Taxable Amount

To determine the taxable portion of a 1031 exchange, investors must analyze the difference between the total value received and the reinvested amount. The IRS taxes the lower of the realized gain or the boot received. The realized gain is calculated by subtracting the original purchase price, adjusted for depreciation and improvements, from the sale price.

Depreciation recapture also affects taxation. Under Section 1250 of the Internal Revenue Code, depreciation deductions reduce the property’s tax basis, increasing the gain when sold. If an investor exchanges a property with a low adjusted basis and receives boot, the portion attributed to prior depreciation is taxed at a maximum rate of 25% instead of the standard capital gains rate.

Transaction costs can help offset boot and reduce taxable income. Certain expenses, such as broker commissions, escrow fees, and title insurance, can be deducted from the sale proceeds before calculating boot. However, costs unrelated to the property transfer, like loan origination fees or inspection costs, do not reduce taxable gain. Properly categorizing expenses ensures an accurate calculation and prevents unnecessary tax exposure.

Reporting Boot to the IRS

The IRS requires taxpayers to report boot received in a 1031 exchange on Form 8824, Like-Kind Exchanges. This form details the properties involved, transaction dates, and gain calculations. Any taxable boot must also be reflected on Schedule D of Form 1040 or Form 4797 if the exchange involves business property. Errors or omissions can trigger audits or penalties under Internal Revenue Code Section 6662, which imposes accuracy-related penalties of 20% on understatements of tax due to negligence or substantial misstatements.

Taxpayers must maintain comprehensive records to substantiate their reporting. This includes settlement statements, qualified intermediary agreements, loan payoff documents, and correspondence detailing how proceeds were handled. If boot arises from debt relief, supporting schedules should illustrate how liabilities were allocated between the relinquished and replacement properties. In multi-party exchanges, tracing funds through escrow accounts is necessary to demonstrate whether any portion was constructively received by the taxpayer.