1031 Boot: What Is Taxed and How to Spread It

How boot works

A 1031 defers gain only on what you receive in like-kind real property. Under IRC 1031(b), if you also receive money or other property, your gain is recognized, but not more than the sum of the money and the fair market value of the other property. Three kinds of boot:

• Cash boot: cash you take at closing, money left with the qualified intermediary when the exchange ends, or exchange funds spent on things that are not real property.
• Mortgage boot: debt on the old property that is paid off or assumed and not replaced on the new one. IRC 1031(d) treats a liability assumed by the other party as money received.
• Other property: personal property, a promissory note from the buyer, or anything else that is not like-kind real property.

Your gain is the smaller of total boot and realized gain. Boot never creates more gain than you have.

Mortgage boot and the netting rules

The netting rules come from Treas. Reg. 1.1031(d)-2, Example 2:

• New debt offsets old debt. Debt you take on for the replacement offsets debt you were relieved of.
• Cash you add offsets old debt. Paying cash into the replacement also offsets debt relief.
• New debt does not offset cash you take. Cash received is boot even if you borrow more on the replacement.

The rule of thumb that avoids all boot: buy replacement property of equal or greater value, reinvest all of the net equity held by the intermediary, and carry at least as much debt (or add your own cash to cover the difference). Customary closing costs such as commissions and title fees generally do not create boot, but using exchange funds for items like loan fees on the new mortgage or repairs can. Ask your CPA to review each closing statement line.

Worked examples

Common assumptions (illustration only): investment land held for years, sold for $2,000,000; adjusted basis $700,000, so realized gain is $1,300,000; no depreciation and no selling costs. Married couple filing jointly, Texas residents, $100,000 of other ordinary income. Tax is the added 2026 federal income tax plus net investment income tax on the recognized gain, computed with the Big Sale Tax engine.

A. Mortgage boot from trading down in debt

The land carries an $800,000 loan, paid off at closing; $1,200,000 of equity goes to the intermediary. The replacement costs $1,800,000: the $1,200,000 plus a new $600,000 loan. Debt relief of $800,000 minus new debt of $600,000 leaves $200,000 of mortgage boot. Recognized gain: $200,000. Federal tax: $27,235. The other $1,100,000 of gain stays deferred. Fix: buy at least $2,000,000 with an $800,000 loan, or keep the $600,000 loan and add $200,000 of your own cash.

B. Cash boot that new debt cannot cure

Same sale, but you take $150,000 in cash at closing and buy a $2,000,000 replacement with $1,050,000 of exchange funds and a $950,000 loan. The extra debt does not offset cash received: $150,000 of cash boot, federal tax $17,835.

C. Boot paid with the buyer's note

No mortgage. The buyer pays $1,600,000 to the intermediary, which buys a $1,600,000 replacement, and the buyer signs a $400,000 note secured by a deed of trust, paying $40,000 of principal a year from 2027 to 2036 plus interest. Under IRC 453(f)(6) the contract price is $400,000 and the gross profit is $400,000, so every principal dollar is gain.

Same boot, $51,485 less federal tax in this illustration, with 2026 brackets held flat and interest left out. Interest on the note is ordinary income.

A 1031 plus an installment sale on the boot

Example C works because the installment method and Section 1031 fit together by statute. IRC 453(f)(6) takes the like-kind property out of the contract price and out of payments, and reduces gross profit by the deferred gain, so only the boot is spread. Treas. Reg. 1.1031(k)-1(j)(2)(iii) treats the buyer's note received through the intermediary as the buyer's own note, so it does not count as a payment when issued. The seller can also receive the note directly from the buyer without breaking the intermediary safe harbor ((k)-1(g)(4)(vii)).

Setup points:

• Decide the split before closing. The purchase agreement should provide for the note, and the exchange agreement should address it.
• The note must be the buyer's own obligation. A note from anyone else, or one secured by cash, is a payment (Temp. Reg. 15a.453-1(b)(3)(i)).
• Protect it like any seller financing: down payment equity, a deed of trust, a personal guarantee where the buyer is an entity, and strong note terms (see the seller financing analysis).
• Cash already sitting with the intermediary cannot later be turned into a note. Left-over cash is taxed when released.

Who it fits, and who it does not

Fits: sellers who want some cash for retirement, debt payoff or diversification while deferring most of the gain; sellers trading into a smaller or less leveraged property; sellers with a buyer willing to carry part of the price on a note; owners with suspended passive losses, since boot gain from a rental is passive income those losses can offset.

Does not fit: sellers who can reinvest everything (a full exchange defers more); sellers whose boot would be mostly depreciation recapture taxed at ordinary rates; buyers who cannot or will not sign a note.

IRS stance and audit risk

Boot is a routine, settled part of Section 1031. You report the exchange on Form 8824 and any installment boot on Form 6252. Points examiners check:

• Debt relief netting computed correctly, and cash boot not offset by new debt.
• Exchange funds used for non-qualifying costs.
• Character of the gain: on depreciated property, recognized boot can carry Section 1245 recapture (limited by IRC 1245(b)(4)) and unrecaptured Section 1250 gain taxed at up to 25%.
• Basis of the replacement: old basis, minus money received, plus gain recognized (IRC 1031(d)).
• For installment boot: a real buyer note, interest at least at the AFR, and no pledging of the note (IRC 453A(d)).

Costs and fees

• The tax on the boot itself, now or as the note is paid.
• Attorney fees to draft the note and deed of trust and to coordinate with the intermediary.
• Intermediary fees, which may be higher if the intermediary holds a note.
• The cost of more debt, if you borrow to avoid mortgage boot.

How it compares with a Section 453 installment sale

A full installment sale spreads the whole gain over the note and leaves you holding a note instead of real estate. A 1031 with boot defers most of the gain inside real estate and taxes only the boot. Combining them, a 1031 plus an installment sale on the boot, defers the exchanged part and spreads the rest. For the full side by side, see 1031 vs installment sale, and try the estimator for a one-year versus spread view.

Frequently asked questions