Last updated on June 25th, 2021 at 11:21 am
Partial 1031 exchange boot calculator | Partial 1031 exchange boot examples | How is boot taxed? | How to avoid boot | Partial 1031 exchange boot FAQs
In a partial 1031 exchange, “boot” refers to any leftover sale proceeds subject to tax.
Boot results from a difference in value between the original property, known as the relinquished property, and the replacement property. When the replacement property has a lower value than the sale price of the relinquished property, that difference is boot. Since that value isn’t being reinvested in the replacement property, the investor pays taxes on it.
Boot can be notoriously tricky to calculate — but our partial 1031 exchange boot calculator below can help you determine how much boot you’re looking at, as well as your partial 1031 boot tax rate.
The two main kinds of boot in a partial 1031 exchange
- Cash boot is when the difference in value between the two properties is in cash.
- Mortgage boot is when the mortgage being paid off on the relinquished property is more than the mortgage being taken out on the new property.
» LEARN MORE: 1031 exchange terms and definitions
Since the main benefit of a 1031 exchange is tax deferral, investors usually regard boot as something to avoid. Sometimes, however, it’s unavoidable — or even desirable, if you need to free up some capital and don’t mind paying some taxes.
If it’s all a little confusing, that’s understandable. If you’re dealing with boot or any other aspect of a partial 1031 exchange, your best move is to consult with an experienced qualified intermediary. Contact us today and we’ll put you in touch with a seasoned expert.
Partial 1031 exchange boot calculator
This calculator will use your information, including your 1031 exchange boot tax rate, to tell you how much boot you can anticipate having — and how big of a tax bill you can expect.
Partial 1031 exchange boot examples
Let’s look at two examples to illustrate how cash boot and mortgage boot work.
Cash boot in a partial 1031 exchange
Say you’re selling a $1 million investment property that’s fully paid off, and you’ve arranged to reinvest the $1 million in cash from the sale through a 1031 exchange, to defer your capital gains taxes.
The new property you’ve targeted is only priced at $750,000. You’re now undertaking a partial 1031 exchange, since you’re not reinvesting all the proceeds from the sale of your relinquished property.
That excess $250,000 is considered cash boot, and is subject to capital gains taxes as well as depreciation recapture.
» LEARN MORE: How to Calculate Depreciation Recapture on Rental Property
Mortgage boot in a partial 1031 exchange
Mortgage boot is incurred when you fail to replace the value of the mortgage relief generated from the sale of the sold property.
Let’s say you sell an investment property for $1 million, and you paid off a remaining $300,000 on the mortgage.
If you use a 1031 exchange to reinvest that money in a $900,000 property, taking on $200,000 in new debt.
That $100,000 gap between what you paid off on the initial mortgage and what you’re taking on is considered mortgage boot, which can always be offset by bringing new cash to the table.
Mortgage boot is a commonly misunderstood topic, and it’s good to have an experienced qualified intermediary to help you address it or even avoid it. Contact us and we’ll help you out!
How is boot taxed in a 1031 exchange?
Boot can be taxed in three different ways, which can be confusing. You’ll have to figure out which rates to apply to different proportions of your gains, depending on:
- how much depreciation you’ve claimed while you owned the property
- what kind of depreciation you claimed
- how much profit (capital gains) you realized on the sale
|Type of tax||Definition||Rate|
|Regular depreciation recapture||A tax on depreciation you’ve claimed in years past||Regular depreciation recapture is taxed as ordinary income, so this is your personal income tax rate, capped at 25%|
|Excess depreciation recapture||A tax on depreciation you’ve claimed that exceeds the amount of conventional “straight-line” depreciation||Excess depreciation recapture is taxed at personal income tax rates, up to 35%|
|Capital gains||A tax on profits gained from the sale of an asset||If you made more than $40,000, your capital gains tax rate will be at least 15%. It’ll rise to 20% if you made more than $445,850.|
» LEARN MORE: Contact us and we’ll connect you with an expert to guide you through your 1031 exchange.
How to avoid boot during a 1031 exchange
By now, you’ve grasped that the point of a 1031 exchange is to defer taxes, and boot is taxable. Therefore, boot should be avoided.
How do you avoid boot? Let’s look at three possible ways.
Follow the like-kind rules
This is the most obvious solution. Make sure your replacement property costs more than the property you’re selling.
Boot is the leftover amount of money that results from your replacement property being worth less than your relinquished property. Scout out only replacement properties that cost more than your relinquished property, so you’re able to invest the entire sale proceeds into your new property.
Reinvesting 100% of the sale proceeds through a 1031 exchange means zero boot — and gets you full tax deferral.
Reinvest the net equity
If you have leftover equity you don’t want taxed as boot, it’s possible to reinvest it in your replacement property by using an improvement 1031 exchange.
Also known as a construction 1031 exchange, or a build-to-suit 1031 exchange, an improvement 1031 exchange allows you to sell your investment property and use the sale proceeds to purchase and improve your replacement property.
For example, you sell your investment property for $500,000. Through an improvement 1031 exchange, you can purchase a $350,000 property and then use that extra $150,000 — which would otherwise end up as taxable boot — to perform improvements and renovations on your replacement property.
Replace the debt
If you’re facing mortgage boot, avoid it by using debt replacement.
Let’s say that when you sold your relinquished property, you paid off a $200,000 mortgage balance but your replacement property only comes with $100,000 in mortgage debt. If you want to avoid $100,000 of mortgage boot, take out an additional $100,000 in mortgage debt on your replacement property, or fill that disparity with $100,000 cash.
Avoiding boot can be tricky, but it’s vital if you want to reap the full tax deferral advantages of a 1031 exchange. Working with a company that has a record of successful 1031 exchanges is the best way to navigate the difficulties of this situation.
» LEARN MORE: Contact us now and we’ll connect you with seasoned industry professionals.
Partial 1031 exchange boot FAQs
What are some partial 1031 exchange boot examples?
In this article, we’ve highlighted the two most common types of partial 1031 exchange boot — cash boot and mortgage boot. But there are other types of potential boot.
Let’s say you sell your investment property and, through a partial 1031 exchange, acquire a replacement property that comes with expensive art, furniture, or industrial equipment as part of the package.
Since these items don’t qualify as real or like-kind property, they’ll be considered boot and will be taxed accordingly.
Similarly, let’s say you acquire an investment property that includes a small cottage you intend to use as a personal residence. Since that cottage isn’t investment property, it’ll be classified as boot.
Also consider a scenario in which you take out some of the proceeds of your initial sale, as cash, before you send the remaining proceeds to the qualified intermediary to be put into escrow. That cash will be taxed as boot.
Is boot always a bad thing in a partial 1031 exchange?
No. If you need capital, and you’re comfortable paying taxes on the boot, it can be a great way to access cash.
Let’s say you’re selling a $500,000 property, and you need $100,000 for a medical emergency or college tuition. You can reinvest $400,000 in a replacement property through a partial 1031 exchange and cash out the remaining $100,000 as boot, which will be taxed.
Similarly, boot can help you reduce your debt. If you have $200,000 in mortgage debt on your $750,000 property, you can use a partial 1031 exchange to flip it for a fully paid off $750,000 property. You’ll pay taxes on the $200,000 in mortgage boot, but you’ll be free of that debt.