Understanding (and Avoiding) a 1031 Exchange Boot

A 1031 exchange boot can force you to pay capital gains taxes on your 1031 exchange. The point of a 1031 exchange is for you to be able to defer capital gains taxes well into the future. If you have to pay taxes on the transaction, you have basically defeated the purpose of entering into a 1031 exchange in the first place. Therefore, when you are getting ready to pursue a 1031 exchange, you should make sure that you understand the rules so that you can avoid a 1031 exchange boot.

1031 Exchange Boot

A 1031 exchange is a type of transaction that you can use when selling a piece of investment property. When you sell your property, if you use that money to purchase another piece of real estate, you can avoid paying any capital gains taxes on the original sale. If the IRS determines that you traded anything that was not like-kind, they will disallow the 1031 exchange. This would mean that you have gotten a 1031 exchange boot. If this happens to you, you will get stuck with a potentially large capital gains tax bill that you are not planning on. There are actually a few different circumstances that could lead to a 1031 exchange boot.

Mortgage Boot

One type of 1031 exchange boot is the mortgage boot. This occurs when you reduce the amount of mortgage debt by trading properties. If you sell a property with a larger mortgage than the property that you buy, this would be considered a mortgage boot. You would then have to pay taxes on the difference between the two mortgage balances.

Cash Boot

Another type of 1031 exchange boot is a cash boot. This occurs when you trade cash or cash equivalents during the exchange. When you get involved with a 1031 exchange, you are supposed to be trading only property that is like-kind. If you trade any cash during the transaction, this will not work. For example, let's say that the seller of the property uses cash to make repairs on the property at the buyer's request. In this case, the amount of money that was used for the repairs would be considered a cash boot. You would then have to pay capital gains taxes on the amount of cash that was used.

Personal Property Boot

Another type of boot that you need to understand is the personal property boot. This occurs when there is any type of personal property that is included in the 1031 exchange. With the 1031 exchange, you are supposed to trade only like-kind property. Therefore, if there is anything else included with the real estate, you may have to pay capital gains taxes on the value of that property. For example, if there are still appliances or furniture in the house, you may have to pay taxes on that amount. Therefore, it is important to make sure that you are dealing with only real estate during this type of transaction.

blog comments powered by Disqus