Exchanging Up & “Boot”
To accomplish a fully tax-deferred exchange the rule of thumb is exchange even or up in value and exchange even or up in equity and in debt.
To the extent that you do not exchange even or up in value and/or exchange even or up in equity and debt, you will have received non-qualifying property (“boot”) in your exchange. If boot is received, tax is computed on the amount of gain on the sale or the amount of boot received – whichever is lower.
The term “boot” refers to any property received in an exchange that is not considered like-kind. real property. Cash boot refers to the receipt of cash. Mortgage boot, which can also be referred to as debt relief, is a term describing a taxpayer’s reduction in mortgage liabilities on the purchase of a replacement property or properties. Personal property received or non-like kind property is also considered boot in 1031 exchange transaction as only real property held for productive use in a trade or business or held for investment qualifies.
If a taxpayer receives cash or other property in addition to like-kind property, this may result in a taxable event. To determine the taxes that may be due, several steps are required. See Asset Preservation’s article, Calculating Capital Gain for more details. First, the taxpayer’s tax advisor must calculate the realized capital gain. Next, the amount of boot, money or other property received, along with any depreciation recapture, must be determined.
The tax advisor will then need to determine the taxes owed for federal capital gain taxes, the depreciation recapture, state taxes (when applicable) and the Section 1411 net investment income tax (when applicable). Finally, a tax advisor will review the taxpayer’s specific situation to see if there are additional tax issues that may offset any current capital gain tax liabilities.