Understanding Boot

Boot is the term used to describe any value an investor receives during a 1031 exchange that is not like kind real property, and it is generally taxable to the extent of the investor's realized gain. Investors in Fort Worth, Texas frequently ask about boot because even a well structured exchange can generate an unexpected tax bill if boot is not planned for in advance. The most common form is cash boot, which occurs when an investor receives cash or other non like kind property from the exchange, often because the replacement property purchased was less expensive than the relinquished property sold. Any leftover exchange funds returned to the investor by the Qualified Intermediary at the close of the exchange are treated as cash boot.

A second common form is mortgage boot, sometimes called debt relief boot, which occurs when the debt paid off on the relinquished property exceeds the debt placed on the replacement property, and the investor does not offset that reduction with additional cash invested into the replacement purchase. For example, an investor in Fort Worth, TX who pays off a larger loan on a sold property but takes on a smaller loan on the replacement property, without contributing additional cash, has generally created mortgage boot. Prior to the Tax Cuts and Jobs Act of 2017, personal property received alongside real property could also create boot, but current law limits Section 1031 treatment to real property, so most personal property received in a modern exchange is treated as boot or is simply excluded from the exchange.

Boot is taxed to the extent of the lesser of the boot received or the investor's realized gain on the transaction, and it is reported on Internal Revenue Service Form 8824 along with the rest of the exchange. Investors generally avoid boot by acquiring replacement property with a purchase price equal to or greater than the relinquished property, and by placing debt equal to or greater than the debt that was paid off, or by contributing additional cash to offset any reduction in debt. Because Texas does not impose a state income tax, investors in the Dallas Fort Worth area evaluating boot exposure are primarily weighing federal capital gains and depreciation recapture consequences rather than an additional state layer, which is a distinct planning consideration compared with investors exchanging property in states that do tax capital gains at the state level.