The word “boot” can sound a little confusing when you first hear it in connection with a 1031 exchange. Simply put, boot refers to money or other value received in an exchange that doesn’t qualify for tax-deferred treatment. Cash is one of the most common examples, but certain differences in debt or other non-like-kind property can also create boot.
Receiving boot doesn’t automatically mean your entire 1031 exchange has failed. Instead, the boot may be taxable to the extent of the gain you realize on the transaction. For example, if you sell a property and end up receiving some cash instead of reinvesting all of the proceeds into qualifying replacement property, that cash could potentially be taxable.
This is one reason investors shouldn’t focus only on finding a replacement property that meets the basic requirements. The financial details of the transaction matter, too. The amount of cash you receive, the manner in which your replacement property is financed and changes in debt can affect the ultimate tax treatment.
The good news is that boot can often be anticipated with proper planning. Before the transaction is completed, talk through the numbers with your qualified intermediary and tax advisor. Knowing where potential boot may come from can help you make better decisions and avoid being surprised by a tax bill later.