1031 EXCHANGE BOOT is any property received from your exchange that is not “like-kind” to the Relinquished Property.
The most common (2) types of boot are cash (i.e., when buying a cheaper Replacement Property than what the Relinquished Property was sold for) and a debt reduction (called “mortgage boot”).
Although exchange boot is taxable at the current capital gains rate (to the extent of gain realized on the exchange), it is possible to have boot and still have a qualifying 1031 exchange (called a “partially taxable sale”). This is fine if you are willing to pay some taxes.
Inadvertently receiving boot in your 1031 exchange, and receiving an unexpected tax bill as a result of it, can be avoided by taking note of the following (6) considerations.
Avoid unexpected tax bills following your 1031 exchange by taking note of the following pointers.[/caption]
1. Always “trade across” or up, but never “trade down,” in order to avoid receipt of boot, either as cash, debt reduction, or both. The extra boot received can be off-set by qualified closing costs paid by you, the exchanger.
2. Bring cash to the closing of the Replacement Property to cover loan fees and/or other charges which are not qualified closing costs.
3. Do not receive property that does not qualify as “like-kind” to the Relinquished Property (such as property held for personal use, business inventory, partnership interests, and stocks and bonds). Vacation homes may qualify only under certain circumstances.
4. Do not over-finance the Replacement Property. Financing should be limited to the amount of money necessary to purchase the Replacement Property after the exchange funds are used up.
5. Do not access exchange funds. These must remain with the Qualified Intermediary (“QI”) until the 1031 exchange is finalized, or else the transaction is blown. The QI is only permitted to release the funds to you under these 3 very limited situations .
6. Real estate investors who flip a lot of properties must be careful here. If you are classified as a real estate dealer for the properties that you own, those properties will be considered inventory and are not eligible for 1031 exchanges.