Partial 1031 Exchanges and "Boot" Explained

What "boot" means

A partial exchange is one where you don't reinvest all of your proceeds or fully replace your debt. The part you keep — the cash or net debt relief — is boot, and boot is taxable in the year of the sale.

The good news: you still defer tax on everything you do reinvest. A partial exchange isn't all-or-nothing. It's "defer most, pay tax on the boot." So if reinvesting every last dollar isn't realistic, a partial exchange still beats a fully taxable sale.

This is general education, not tax advice — your CPA should run the actual numbers for your situation.

The two ways to fully defer

To defer all of your gain, you generally must satisfy two tests:

• ›Equity test: reinvest all of your net proceeds (don't pocket cash).
• ›Value/debt test: buy a replacement of equal or greater value, and carry equal or greater debt (or add new cash to replace any debt you paid off).

Fall short on either test and you create boot. Boot comes in two flavors.

Cash boot

Cash boot is the most obvious kind: any sale proceeds you take out instead of reinvesting.

Illustrative example: you sell for $1,000,000 and buy a replacement for $900,000. That $100,000 difference is cash boot and is generally taxable (up to the amount of your gain).

You receive it through your QI — the QI returns leftover, unused funds once your identification or exchange period ends. Note: cash you pull *out at the start* and cash *left over at the end* are both boot. You can't route around the rules by structuring the timing.

Mortgage (debt) boot

Mortgage boot is less intuitive and catches people off guard. To fully defer, you must replace the debt you paid off, not just the equity.

Illustrative example: your old property had a $400,000 mortgage, and your new property has only a $250,000 mortgage. The $150,000 of debt relief is mortgage boot — taxable even if you reinvested every dollar of cash equity.

The reason: paying off a loan and not replacing it is economically like taking cash out. The IRS treats relief from debt as a benefit you received.

You can offset mortgage boot by adding new cash to the deal — putting in an extra $150,000 of your own money to bring total debt-plus-new-cash up to the prior level. Importantly, you can offset mortgage boot with cash, but you cannot offset cash boot by taking on more debt beyond what's needed.

A fully worked example

Suppose you sell a rental:

• ›Sale price: $1,000,000
• ›Mortgage payoff: $400,000
• ›Net equity to QI: $600,000
• ›Realized gain: $500,000

Scenario A — buy for $1,000,000 with a $400,000 loan and reinvest all $600,000: no boot, full deferral.

Scenario B — buy for $850,000 with a $250,000 loan, take $150,000 cash: - Cash boot: $150,000 (proceeds kept) - Mortgage boot: $150,000 debt relief — but it can be offset because you reinvested $600,000 of equity into $600,000 of equity; the shortfall is on the value side. In practice your advisor nets cash and debt positions together. - Net taxable boot: roughly $150,000, taxed up to your gain.

The exact mechanics of netting cash and debt are detailed and fact-specific — this is exactly why you run the numbers with a CPA before closing.

How boot is taxed

Boot is taxable up to the amount of your realized gain (you can't be taxed on more than you actually gained). Depending on your situation, that boot can carry:

• ›Capital gains tax — 0%, 15%, or 20% federally on the gain portion, plus state tax.
• ›Depreciation recapture — taxed at a federal rate of up to 25%, and recapture is generally triggered first before lower-rate capital gains.
• ›The 3.8% net investment income tax (NIIT) for higher-income investors.

Because recapture is taxed first and at a higher rate, even a "small" amount of boot can be taxed at a meaningful blended rate — sometimes higher than people expect.

Common mistakes that create accidental boot

• ›Buying down to a cheaper property without realizing the value gap is taxable.
• ›Refinancing right before an exchange to pull out cash (the IRS may scrutinize cash-out refis done in contemplation of an exchange).
• ›Forgetting closing costs. Some costs can be paid from exchange funds without creating boot; others (like loan fees or prorated rents) may. Ask your QI which is which.
• ›Reducing debt without adding offsetting cash.
• ›Pulling out "just a little" cash at closing for convenience, not realizing it's fully taxable.

When taking boot on purpose makes sense

Sometimes intentional boot is the right call:

• ›You need liquidity for another purpose and accept the tax.
• ›The best replacement property simply costs less than what you sold.
• ›The tax on a modest boot is acceptable relative to forcing a worse deal just to avoid it.

The key is to decide intentionally and know the number in advance.

What this means for you

To fully defer, follow the classic rule of thumb: buy equal or up, reinvest all your proceeds, and replace your debt (or cover the gap with new cash). If you want cash out, treat it as a deliberate decision — ask your CPA to quantify the tax, including recapture and NIIT, before you sign. A partial exchange can be a smart, flexible tool; accidental boot is just an avoidable surprise.