Boot Tax and Estate Tax for 1031 Exchange Properties (Part 2 of 3)

By Tim Vi Tran, | Nov 25, 2025 | Industrial properties, commercial real estate investment, commercial property 1031 exchange

Boot tax from 1031 Exchange properties can be cash, mortgage, debt, Non-like-kind property boot, upon tax basis, recognized or deferred gain.

In Part 1, “1031 Exchange: How Savvy Investors Keep More Capital Working with This Tax Deferral Tool”, one area we discussed, among others, was “Tax Basis Step-up Erases Capital Gains Tax and Depreciation Recapture”.

In Part. 2 here we will discuss, very briefly, about estate taxes and different state inheritance taxes, then we zoom in on boot tax related to 1031 Exchange properties.

Coming up next in Part 3, we will wrap up boot tax issues: (1) How does the IRS prioritize ordinary income tax, capital gain, cash boot, debt boot, and non-like-kind property? (2) Why isn’t boot automatically “bad”, and when can it be strategically smart?

To watch it as a 16-min video

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Disclaimer:

All information shared here in this article, and in all blogs, case studies, and courses offered by the Ivy Group are for general education only, not as tax, legal, or investment advice. Please seek professional advice from tax, accounting, legal, and other professionals.

Estate tax:

Step-up in basis applies to income tax when an inherited property is passed to the next generation from the owner, but the estate tax is a separate and different tax system altogether. If your estate’s total value (including the property) exceeds the federal estate tax exemption ($13.99M in 2025 per individual), heirs might owe estate tax even though the capital gains are erased.

State rules: Some states impose their own estate or inheritance taxes with exemptions lower than the federal.
Risk of rule changes: Step-up in basis is politically debated. Proposals have surfaced to eliminate or limit it, even though no law has passed yet.

Boot Tax:

In 1031 exchange of real estate properties, what happens when less than 100% of the proceeds of the sale are used to purchase the replacement property?

The short answer is: if you roll less than 100% of your net sale proceeds (and debt) into the replacement property in a 1031 Exchange, the leftover proceeds are “boot.” Boot is taxable now, up to the lesser of your realized gain or the amount of boot received. (We will explain what constitutes “realized gain” later in this article). The rest of the gain stays deferred into the basis of the new property, per IRS Publication 544.

How does boot show up

How does boot show up (cash, debt relief, non-like-kind property) so you can spot where your transaction might trigger it? – Boot usually sneaks in three main ways:

Cash boot

You sell a property for $1M, but only roll $900K into the new one. That leftover $100K is cash boot and taxed as capital gain.
You take money out at closing (e.g., “just reimburse me my equity”) — IRS sees that as taxable.

Mortgage / debt relief boot

Say your old property had a $500K mortgage, and your new one only has $300K debt. Unless you add $200K cash to the deal, that $200K difference counts as boot.
Important: debt reduction is treated the same as receiving cash.

Non-like-kind property boot

If in the exchange you also get something that’s not real property (i.e., personal property, equipment, goodwill, etc), the fair market value of that portion is taxable.

Closing costs and fees nuance

Certain expenses (broker fees, transfer taxes, title insurance) can soak up potential boot. But if exchange funds pay for costs not directly tied to the sale / purchase (like loan fees or prorated rents), those can create taxable boot.

So the triggers are: leftover cash, lower debt, or extra “non-like-kind”, non-real-estate property.

Tax consequences when proceeds are underutilized

Recognized (taxable) gain: the lesser of (a) realized gain, or (b) net boot received. Cash boot is always taxable; debt boot can be offset with additional cash contribution at purchase.
Character of gain: some or all of the recognized amount may be depreciation recapture (at ordinary income tax rates), with any remainder as capital gain. IRS Pub. 544 has detailed recapture examples.

Examples of Cash Boot and Debt Boot

1) Cash boot from “leftover” proceeds

Sell relinquished property for $1,000,000; adjusted basis $400,000; no debt.
Realized gain = $600,000.
You buy a replacement for $950,000 and let $50,000 come back to you as cash.
Boot received: $50,000 → Taxable gain recognized: $50,000 (because it’s less than the $600,000 realized).
Deferred gain: $550,000.
New basis: $400,000 − $50,000 (cash received) + $950,000 (paid) − $1,000,000 (amount realized given up) + $50,000 (recognized gain) = $350,000. (Same result using the IRS worksheet on Form 8824.)

2) Debt boot (trading down in leverage)

Sell for $1,000,000 with a $300,000 mortgage paid off at closing (equity $700,000).
Buy replacement for $950,000 with a new $200,000 loan; you use all $700,000 exchange cash.
You reduced debt by $100,000 compared to the old loan. That $100,000 is debt relief boot unless you bring in $100,000 extra cash or increase the new loan to keep total value and debt at least equal.
Recognized gain: up to $100,000, limited by realized gain, per this article.

How people avoid boot (rules of thumb)

Equal or greater: Buy equal or greater value, invest all net equity, and take on equal or greater debt (or replace any debt reduction with new cash). That combination eliminates both cash and debt boot.
Spend exchange funds on qualifying costs: have your QI apply proceeds to allowable exchange expenses (such as broker fees, transfer fees, title insurance, etc), not non-qualifying costs (such as loan fees, reserves, etc), at closing to avoid inadvertent cash boot.
Model it on Form 8824 before closing: your CPA / QI can run the exact lines 15–25 to see if any boot will be recognized.

All like-kind exchanges are reported on Form 8824 for the tax year the relinquished property was transferred. The form walks through realized gain, boot, recognized gain, and your new tax basis.

Recognized Gain vs. Deferred Gain; Replacement Basis

To see exactly how much is deferred, how much is taxable boot, and what your new basis would be, using the Form 8824 framework for 1031 exchange, we need to first have these numbers:

Sale price of the relinquished property
Adjusted basis (value after depreciation)
Debt paid off at sale
Purchase price of the replacement property
New debt on the replacement property
Any cash you put in or took out

The following example lays it out step by step, so you can see where boot shows up, what’s taxable now, and what rolls forward into the replacement property’s basis.

Example Facts:

Sale price (relinquished property): $1,200,000
Adjusted basis: $500,000
Mortgage paid off at sale: $400,000
Net equity (proceeds available): $800,000
Replacement property purchase price: $1,000,000
New mortgage taken: $200,000
Exchange cash used: $800,000

Step 1. Realized Gain

Sale price $1,200,000 − basis $500,000 = $700,000 realized gain

Step 2. Compare Debt

Old debt = $400,000
New debt = $200,000
→ $200,000 debt relief. Unless you put in $200,000 new cash, this is debt boot.

Step 3. Boot Received

Cash boot: none (you rolled all $800k into the new property).
Debt boot: $200,000.
→ Total boot: $200,000

Step 4. Recognized (Taxable) Gain

Taxable gain is the lesser of realized gain ($700k) or boot ($200k).
→ Recognized gain = $200,000
This is what you’d pay tax on this year (with some portion potentially depreciation recapture).

Step 5. Deferred Gain

$700,000 realized − $200,000 recognized = $500,000 deferred

Step 6. Basis of Replacement Property

Formula: Basis(new) = Basis(old) + Gain recognized + Money paid − Money received

= $500,000 + $200,000 + $1,000,000 (purchase) − $1,200,000 (sale price)
= $500,000 basis

So the new property carries a low basis relative to its market value, embedding that $500k deferred gain.

📌 Takeaway: because the replacement purchase was lower in value and debt than the sale of the relinquished property, you triggered $200k of taxable boot. Had you bought a $1.2M+ property and kept debt at $400k+, all $700k gain would’ve been deferred.

In a 1031 exchange, the “boot” is any cash, debt relief, or non-like-kind property you receive when the deal doesn’t perfectly balance. Boot is taxable, so it breaks the full tax deferral. A few angles you can consider:

Accept and pay tax: If you’re fine with partial deferral, just recognize the boot as capital gain. Sometimes the amount is small enough that the tax hit is negligible compared to the benefits of the exchange.
Reinvest more: You can sometimes avoid boot by increasing the value of your replacement property (or injecting extra cash at closing) so that you’re trading equal or greater value.
Structure carefully: If the boot is coming from debt mismatch (less debt on the replacement property), you can offset by adding cash to close.
Plan for timing: If it’s inevitable, you can factor the tax into your overall strategy—sometimes deliberately taking some boot is smarter than forcing a less suitable property purchase just to avoid it.
Use professional guidance: A tax advisor or qualified intermediary can help structure 1031 Exchange transactions so the impact is minimized by applying qualified closing costs to absorb some boot.

Sometimes the Perfect Tax Deferral Is NOT Worth Chasing

It comes down to whether you want to maximize deferral or optimize portfolio fit. Sometimes the perfect tax deferral isn’t worth chasing if the asset trade is strategically better with a little boot.

In Part 3, we will wrap up with these issues: (1) How does the IRS prioritize ordinary income tax, capital gain, cash boot, debt boot, and non-like-kind property? (2) Why isn’t boot automatically “bad”, and when can it be strategically smart?

Applying the 1031 Exchange and related tax and estate planning rules to specific transactions takes years of experience

It is one thing to list all the rules, but quite another to apply the rules to specific cases.

Like playing basketball, learning all the rules of the game won’t get you anywhere, you need to practice over and again on the court. To win a game requires so many factors beyond experience: mental focus, teamwork, strategies, quick reaction, understanding the big picture, flawless execution, planning the details ahead…

To learn how these 1031 Exchange and related rules are applied in unique situations with moving targets and various puzzle pieces, you can access, for a small fee, case studies: https://theivygroup.com/course-category/deal-structure-1031-exchange/

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