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How to Avoid Taxable "Boot"

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What Is Boot?

The term “boot” gets thrown around plenty in this industry.

 

“Cash boot”

“Mortgage boot”

It’s kind of a cool term. Feels like old-fashioned vernacular.

But what does it mean?

As we explain in our Examples of “Boot” post

If you receive a “boot” item, you’re taxed on its value.

The most common 1031 boot item is cash.

Let’s explore that next.

How to Avoid “Cash Boot”

How to Avoid “Cash Boot”

Take out cash when you sell?

It all becomes taxable. The same is true if you later receive cash from your 1031 escrow account.

Here’s an example.

That $50K instantly becomes taxable at the highest applicable rate.

It doesn’t matter what you do with the $50K.

Even if you replace the $50K when you purchase a replacement property, it’s still taxable.

Bummer.

The next most common kind of boot is debt relief.

How to Avoid “Mortgage Boot”

How to Avoid “Mortgage Boot”

Fail to replace the value of the mortgage on your relinquished property?

That’s taxable too.

This is how it works.

Imagine you sell a relinquished property for $500K. But you only purchase one replacement property for $400K.

This time, all of the equity went into the replacement property.

But you traded down by $100K.

Here’s what the IRS sees:

You Gave Up

    • $500K in real property

You Received

    • $400K in real property
    • $100K in debt relief

Debt relief is not “like-kind” to real property.

(Pro Tip: You can replace the amount of debt by adding new debt on to your replacement property or bringing new outside cash to the deal)

For example, this is a completely tax-deferred 1031 exchange.

You could accomplish the same goal by simply increasing the principal on your new mortgage.

Two Simple Rules to Avoid Boot

Two Simple Rules to Avoid Boot

No reason to over-complicate.

Here are the two most important rules for all 1031 exchanges.

01

Buy property(ies) worth at least as much as what you sold

02

Transfer all net equity into your replacement property(ies)

These will avoid almost all major boot items.

Beyond these, work closely with your qualified intermediary and tax advisor.

Learn to Master 1031 Exchanges

Whether you are brand new, or need an advanced strategy, this is your go-to center for Section 1031 Exchanges.

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