“Boot” is a term referring to the portion of a property’s value that is not replaced during a 1031 exchange transaction. This is important to an investor because they will have to pay taxes on any boot their transaction generates.
Many investors don’t realize that ALL of the boot is considered gain, so in many cases the tax bill can be a big one.
Here’s what you need to know about the different kinds of “boot”… and how you can avoid each of these costly pitfalls.
Different Types of Boot (and how to avoid them)…
- Cash Boot: This is often the most common type of boot in an exchange. Simply put, any cash that you receive during the 1031 exchange process is considered boot. Investors often take cash out of a transaction for personal reasons, perhaps to fund a child’s education or pay for current expenses.
>> How to avoid it: This is the most common, but also the easiest to avoid. If you don’t need the cash – don’t take it! Reinvest 100% of the net sale price of your relinquished property.
- Debt (or Mortgage) Boot: If you sell a property and pay off a note or a mortgage – you have to replace it somehow in the exchange. If you don’t the amount of money not invested equal to the debt will be considered boot.
>> How to avoid it: There are two ways to avoid debt boot. 1. Obtain “new debt” on the new property to replace the debt you paid off. If you had a $100,000 mortgage on your relinquished property, obtain a $100,000 mortgage on your replacement property (or purchase a DST that can provide that amount of debt). 2. Add cash to the purchase of the replacement property. In that same example, instead of obtaining new debt, simply add $100,000 of “new cash” to purchase your relinquished property.
- Non-Transactional Costs: Qualified transactional costs are typically not considered boot. These are things like realtor fees, closing costs, and title work. However often real estate sales might incur non-transactional costs. These are things like rent prorations, tax prorations, and any other charges to the seller that are unrelated to the closing of the replacement property. These are typically considered boot.
>> How to avoid it: Pay for all of your non-transactional costs “out of pocket” rather than out of the sale proceeds of the relinquished property.
To learn more about this topic book a virtual meeting with one of our highly experienced 1031 exchanges experts today!