Boot in a 1031 Exchange: Cash, Mortgage, and Netting Rules

Boot in a 1031 exchange is the portion of the deal that doesn’t qualify for tax deferral: any cash, debt relief, or non-real-property value you receive alongside the like-kind real estate. You owe tax on that amount, capped at your total realized gain on the sale.¹ The rest of your gain rolls into the replacement property untaxed. Getting to zero boot, or knowing exactly what you’ll owe if you can’t, comes down to how cash and debt move through the transaction and how the netting rules treat each piece.

The Two Forms of Boot

The statute is short on the point: if you receive “other property or money” in the exchange, you have boot.¹ In practice, it shows up in two forms.

Cash boot is money or non-qualifying property you walk away with. Mortgage boot is net debt relief: dropping from a larger loan on the old property to a smaller loan on the new one. Both produce the same result on your return, which is recognized gain in the year of the exchange up to the amount of your realized gain.

Since the Tax Cuts and Jobs Act, Section 1031 covers real property only. Equipment, vehicles, artwork, and other personal or intangible property no longer qualify.² If personal property gets bundled into a real estate deal, its value is boot no matter how the closing is papered.

How Cash Boot Shows Up

The classic case is simple: your sale price exceeds what you spend on the replacement, and the difference lands in your pocket. Any exchange proceeds still sitting with your intermediary after closing on the replacement property also become taxable cash boot. You cannot leave money on the table and treat it as still part of the exchange.³

Beyond literal cash, anything of value that isn’t qualifying real estate counts. Promissory notes taken back from the buyer, partnership interests, stocks, and personal property included in the deal all fall in the same bucket.

The IRS looks past whether the money sits in your account. If you have access to the sale proceeds or the power to direct them for personal use, that constructive receipt is taxable even before the funds physically reach you. This is why nearly every deferred exchange runs through a qualified intermediary that holds the proceeds and buys the replacement on your behalf.⁴ As long as you respect the restrictions on touching those funds, the arrangement prevents constructive receipt.⁵

How Mortgage Boot Shows Up

The statute says that when the other party assumes your debt, the relief is treated as money received.¹ Trade a property carrying a $500,000 mortgage for one with a $400,000 mortgage, and the $100,000 reduction is treated the same as $100,000 in cash. No check changes hands; the financial benefit is the same to the IRS.

Mortgage boot catches investors off guard because it can appear even when every dollar of sale proceeds goes into the replacement property. Sell for $800,000, buy for $800,000, but drop your loan from $500,000 to $350,000, and you’ve reduced debt by $150,000 even though you added $150,000 of your own cash to close. Whether that leaves you with taxable boot depends on the netting rules.

Refinancing Before or After the Exchange

Some investors try to sidestep mortgage boot by taking a large loan on the replacement property and refinancing soon after to pull cash out. Under the step transaction doctrine, the IRS can collapse those moves into one transaction. If the refinance looks planned as a way to extract equity tax-free, the pulled-out cash can be reclassified as boot. Most tax advisors suggest waiting six to twelve months before refinancing a replacement property acquired through a 1031 exchange, and the same caution applies to refinancing the relinquished property just before the sale.

The Netting Rules

Whether you actually owe tax depends on how the moving parts net against each other. Treasury regulations say that liabilities you assume in the exchange offset liabilities you were relieved of; only the net difference is boot.⁶

Debt Against Debt

If you shed a $500,000 mortgage and take on a $600,000 mortgage, you have zero mortgage boot. The larger new debt more than covers the old one. Reverse it and drop from $500,000 to $300,000, and the $200,000 difference is mortgage boot.

Cash Paid Offsets Debt Relief

You can erase mortgage boot by bringing personal cash to closing. Write a check for $200,000 to cover the gap in debt, and that cash offsets the debt relief dollar for dollar. The Form 8824 instructions spell it out: net liabilities are calculated by subtracting liabilities you assumed, plus cash you paid, plus non-like-kind property you gave up, from the liabilities the other party assumed.⁷ Investors who want to deleverage on the replacement side can do it without triggering tax, as long as they bring enough cash.

The One-Way Rule

The offset only runs one direction. Cash you pay in can eliminate mortgage boot, but taking on a bigger mortgage cannot eliminate cash boot you receive. Pocket $50,000 from the exchange and borrowing an extra $50,000 on the replacement property does not cancel it out. On Form 8824, cash received and net liability relief are separate line items that get added together.⁷ The reasoning: allowing debt to offset cash withdrawals would turn every cash-out refinance into a tax-free event.

How Much of the Boot Is Taxable

Once you know your net boot, one more guardrail applies. You recognize the lesser of net boot received or your realized gain on the sale, but not less than zero.⁷

Say you sell a property for $800,000 that you bought for $600,000. Your realized gain is $200,000. If a debt reduction leaves you with $300,000 in net boot, you don’t owe tax on the full $300,000, because your actual profit was $200,000. Recognized gain caps at $200,000. Flip the numbers, and a $400,000 realized gain with only $50,000 of boot means you recognize $50,000 and defer the remaining $350,000.¹

The lesser-of rule does not help with losses. If the exchange produces a net loss, you cannot recognize it even if you received boot. Section 1031(c) bars loss recognition when boot is involved.¹

The Rates That Apply to Boot

Recognized boot is not all taxed at the same rate. The gain stacks in a specific order.

Depreciation recapture is taxed first. Gain attributable to depreciation you previously claimed on the relinquished property is unrecaptured Section 1250 gain at a maximum federal rate of 25%. Claim $80,000 in depreciation over the years and receive $120,000 in boot, and the first $80,000 is recaptured at up to 25%.⁸
Long-term capital gains rates apply to the remainder, at 0%, 15%, or 20% depending on income. For 2026, the 20% rate applies above $545,500 for single filers and $613,700 for married couples filing jointly. Most investors below those thresholds pay 15%.
The 3.8% Net Investment Income Tax applies if your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). It hits the lesser of your net investment income or the amount above the threshold.⁹

For a high-income investor with meaningful depreciation history, the effective federal rate can reach 28.8% on the recapture portion and 23.8% on the rest. Small amounts of boot can produce a larger tax bill than the dollar figure suggests.

Closing Costs That Create or Reduce Boot

Not every closing cost has the same effect. Costs directly tied to the sale and purchase of the exchanged real estate can be paid from exchange funds without creating boot. Treasury regulations treat customary transactional items as exchange expenses: broker commissions, recording fees, transfer taxes, title company fees, and qualified intermediary fees. The Form 8824 instructions let you reduce your boot amount by these exchange expenses.⁷

Financing costs are different. Loan origination fees, points, lender-required appraisals, and mortgage insurance premiums are costs of obtaining the loan, not costs of acquiring the property. Paying them from exchange proceeds turns those dollars into boot. Prorated rent, insurance premiums, security deposits, and utility bills are operating items and get the same treatment. A useful test: if the expense would disappear in an all-cash purchase, it is probably a financing cost that creates boot when paid from exchange funds.

The clean workaround is to bring personal funds to closing for loan-related fees and prorated operating items. That leaves the exchange proceeds intact and dedicated entirely to the replacement property.

Reporting Boot and Basis Carryover

Every 1031 exchange is reported on Form 8824, whether or not boot was received. The form runs the calculation: fair market value of like-kind property received, plus boot received, minus your adjusted basis and exchange expenses, equals realized gain. Recognized gain is the smaller of boot received or realized gain.⁷ You file it with your return for the year the relinquished property was transferred.

The form also sets the basis of your replacement property. New basis equals the old basis, decreased by any money received, and increased by any gain recognized.¹ The deferred gain lives inside that lower basis. Sell the replacement later without another exchange, and the accumulated gain comes due. Section 1031 defers tax; it does not erase it.

1
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
2
Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
3
Internal Revenue Service. FS-2008-18, Like-Kind Exchanges Under IRC Section 1031
4
Internal Revenue Service. Revenue Procedure 2003-39 – Safe Harbors for Like-Kind Exchange Programs
5
Internal Revenue Service. Sales, Trades, and Exchanges – Frequently Asked Questions
6
eCFR. 26 CFR 1.1031(b)-1 – Receipt of Other Property or Money in Tax-Free Exchange
7
Internal Revenue Service. Instructions for Form 8824 – Like-Kind Exchanges
8
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
9
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax