Guides / 1031 exchanges

What is mortgage boot?

The 1031 rule that surprises the most exchangers: you can buy a more expensive property and still owe tax this year.

Boot in one sentence

A 1031 exchange defers your gain only to the extent everything stays invested — any value you take out of the exchange is called boot, and gain is recognized (taxed now) up to the amount of boot you receive.

Boot comes in two flavors. Cash boot is equity you pocket: your exchange produces $800k of net proceeds but you only put $600k into the replacement, so $200k came off the table. Mortgage boot is debt relief: you paid off a $500k loan on the old property but only took a $350k loan on the new one. The IRS treats that $150k of vanished debt as if you'd received cash.

The trade-up trap

Here's the scenario that catches people. You sell for $1.2M and buy for $1.5M — a clear trade-up, so you assume full deferral. But you financed the new property at 60% LTV. The bigger loan means less of your equity went in: the exchange produced $800k of proceeds and the replacement only absorbed $600k of equity. That $200k difference is cash boot, and it's taxable — even though the building you bought costs more than the one you sold.

The rule of thumb that actually works: to fully defer, reinvest all of your net equity AND carry equal-or-greater debt on the replacement (or make up reduced debt with fresh cash). Purchase price alone tells you nothing.

Offsetting mortgage boot

Debt relief can be cured with cash: if your new loan is $150k smaller but you add $150k of fresh money to the purchase, the boot is offset. It doesn't work the other way — taking extra debt on the replacement never shelters cash you pocketed.

How recognized gain gets taxed

Boot doesn't blow up the whole exchange — it makes gain taxable up to the boot amount, and the IRS ordering rules apply depreciation recapture first (federally up to 25%) before long-term capital gain rates. On a property you've held and depreciated for years, that ordering makes boot more expensive than people expect.

Pencil it before you structure it

The 1031 Exchange Calculator runs this exact math: enter your sale, your debt, and your replacement structure, and it flags cash boot and mortgage boot separately — with the tax bill on each — before your identification window starts ticking.

This guide simplifies; partial interests, related-party transfers, and state-level rules add wrinkles. Not tax advice — confirm your structure with a CPA and a qualified intermediary.