1031 Exchange Education- What is Boot?

The mar­ket is start­ing to loosen up for investors seek­ing to sell their prop­er­ties via §1031 tax deferred exchange. Once under con­tract investors need to under­stand a few spe­cif­ic items that may cause either a unin­tend­ed tax issue or an issue with an expense tak­en at clos­ing that is not per­mit­ted in a §1031 exchange.  

March 4, 2025

By Al DiNi­co­la, AIF®
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

Recent­ly we have received calls from investors seek­ing infor­ma­tion on what cash they can retain, what hap­pens when the loan is paid off, and how rental and secu­ri­ty deposits are han­dle at clos­ing. We do not pro­vide tax advice.

Let’s han­dle one item at a time. There is an item ref­er­enced as boot in an exchange. “Boot” refers to any por­tion of a §1031 exchange that does not meet the like-kind replace­ment prop­er­ty cri­te­ria. Most com­mon­ly this is in the form of “cash boot” and “mortgage/debt boot.”

Cash boot occurs when an investor has unin­vest­ed pro­ceeds from the sale of a replace­ment prop­er­ty. If they intend to do a §1031 exchange but do not replace all of the cash received from the sale, they will owe tax on the unin­vest­ed por­tion.

Exam­ple:

If an investor sells an invest­ment prop­er­ty for $2,000,000 and they pur­chase a replace­ment prop­er­ty for $1,500,000, they will have a $500,000 cash boot that will be sub­ject to tax. The investor would be sub­ject to fed­er­al and state tax­es depend­ing on where they live.

It has been brought to our atten­tion in a few invest­ment sem­i­nars that cer­tain investors will over paid for their replace­ment prop­er­ty. This occurs when cal­cu­lat­ing the poten­tial tax­es that may be due on not using all the cash, when com­pared to sim­ply pay­ing more for the prop­er­ty (aka the ask­ing price or even high­er). If you are pay­ing cap­i­tal gains tax­es, have a high income that may sub­ject you to NIIT (net invest­ment income tax), and live in a high income tax state you may face up to 40% tax­es on the boot. Oth­er investors (accred­it­ed) may deter­mine they would rather nego­ti­ate a bet­ter price on the replace­ment prop­er­ty (mean­ing not using all the cash pro­ceeds in the exchange) and then uti­lize a Delaware Statu­to­ry Trust (DST) for any remain­ing cash boot.  DSTs are scal­able and can  han­dle left over cash from the exchange.

Mortgage/debt boot occurs when the mort­gage val­ue on the replace­ment prop­er­ty is less than the mort­gage on the relin­quished prop­er­ty. It is impor­tant to con­sid­er this when doing a §1031 exchange as both the cash received AND the debt need to be replaced in the acquired prop­er­ty.

Exam­ple:

An investor sells an invest­ment prop­er­ty with a $500,000 mort­gage and pur­chas­es a replace­ment prop­er­ty uti­liz­ing a $400,000 mort­gage. This investor will be sub­ject to tax on a mort­gage boot in the amount of $100,000. It is impor­tant to note that this boot can be off­set by adding $100,000 of cash to the exchange.

The eas­i­est way to avoid a “boot” issue is to remem­ber that you are replac­ing the total real estate val­ue in a §1031 exchange. Both the equi­ty and debt from the relin­quished prop­er­ty need to be equal or greater in the replace­ment prop­er­ty.

There are rea­sons why an investor may have trou­bles with the replace­ment loan.  In the short 45-day iden­ti­fi­ca­tion win­dow the investor may need to qual­i­fy for a loan.  Grant­ed, there is a total of 180 days to close but most investors may wish to guar­an­tee there is loan approval pri­or to iden­ti­fy­ing the replace­ment prop­er­ty. Accred­it­ed investors may seek to uti­lize Delaware Statu­to­ry Trust (DSTs) as a replace­ment prop­er­ty.  DSTs pro­vide non-recourse debt pre pack­age for investors with­out appli­ca­tion or effects on indi­vid­ual cred­it reports.

When we work with an accred­it­ed investor we take into con­sid­er­a­tion suit­abil­i­ty of replace­ment assets as well as bal­anc­ing the uti­liza­tion of cash and the inclu­sion of replace­ment debt if nec­es­sary.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

DSTs are not for all investors.  The acqui­si­tion of a DST is for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC 1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035  MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.