In this 1031 FAQ video, Jeff Peterson explains what boot is in a 1031 exchange and how to best avoid it. Watch more 1031 educational videos here.
There are many terms of art in the 1031, and one of the most often used words is boot.
If you sell an apartment building and you receive cash, that would be considered boot or non like-kind property that you receive during the exchange. If you want to defer every cent of tax, you want to avoid receiving boot and only receive like-kind replacement property.
How are some common ways that people receive boot? When you sell the relinquished property if the buyer says “hey I don't have enough money to pay for this thing, can I give you an IOU or a promissory note for a portion of the purchase price?” If the taxpayer selling the property takes that IOU or note guess what they’ve just received? Boot. If you want to have a simple 1031 exchange, avoid seller-backed financing.
Another way that you can receive boot is on the purchase of the replacement property. You need to make sure that all of your equity, all of your net proceeds gets applied for the purchase of your like kind real estate.
There's a couple different ways that you can walk off the dock on the replacement side. One way is to have too large of a mortgage or deed of trust on your replacement property such that you don't end up applying all of your exchange funds for the purchase and you end up getting back surplus or unused exchange funds at the bottom of the settlement statement.
You want zero cash due to the buyer. You want all of your funds to be applied towards the purchase price which might mean that you have to ratchet back your lender and make sure they only loan you the amount you need to make up the purchase price.
Another way that you could end up inadvertently receiving boot on the replacement property is if you receive non like kind property as part of the purchase of the replacement property. For example, if you buy a fully furnished condominium with a brand-new granite table and that table is a movable item of personal property or chattel you want to make sure that you pay for the furnishings with non 1031 funds not the use of your exchange for me because that money that you applied towards the purchase of the furniture could result in you end up receiving boot with your exchange funds not like-kind real estate.
- 1031 Hotline: If you have questions about boot in a 1031 exchange, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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