1031 Exchange: What is a Mortgage Boot? | DST Investment

If you are familiar with the term “1031 exchange”, you may have also heard of the phrase “mortgage boot.” But what does this mean? In order to understand what a mortgage boot is, it’s important first to have a basic understanding of what a 1031 exchange is. In this article, we will provide an overview of both concepts to help you learn the important facts about these scenarios. First, let’s look at what a 1031 exchange is.

What is a 1031 Exchange?

A 1031 exchange, also known as a like-kind exchange or Internal Revenue Code 1031, is a method by which investors can defer capital gains taxes on the sale of investment property by reinvesting the proceeds from the sale into another “like-kind” investment property. 

In order for an exchange to be considered “like-kind,” both properties must be used for business or investment purposes, and they must be of the same nature or character. For example, an investor could exchange a rental property for another rental property but not for a primary residence.

The main benefit of a 1031 exchange is that it allows investors to defer capital gains taxes on the sale of an investment property. This can be a significant advantage, especially for those who are looking to reinvest their profits back into the market in order to grow their portfolio. 

It’s important to note that 1031 exchanges must be completed within a certain time frame in order to qualify. Investors have 45 days from the date of the sale of the first property to identify potential replacement properties, and they must close on the purchase of the replacement property within 180 days of selling the original property. 

Now that we’ve covered the basics of what a 1031 exchange is, let’s take a closer look at mortgage boot.

What is a Mortgage Boot?

In a nutshell, mortgage boot occurs when a taxpayer receives cash or other consideration in a 1031 exchange that is greater than the mortgage debt they are assuming on the replacement property. 

For example, let’s say an investor sells a rental property for $200,000 and uses the proceeds to purchase a replacement property for $250,000. The investor would then be responsible for paying the remaining $50,000 out of pocket. However, if the investor also assumed a mortgage on the replacement property for $100,000, then the total amount of cash or other consideration received in the exchange would be $150,000 – which is less than the $200,000 of mortgage debt assumed. In this case, the excess cash or other consideration would be considered mortgage boot.

Mortgage boot can have significant tax implications for investors, so it’s important to be aware of this concept before entering into a 1031 exchange. If you are considering an exchange, be sure to consult with a tax professional to ensure that you understand all of the potential consequences.

What is Equity Boot?

Equity boot is another term that you may come across in the context of a 1031 exchange. Equity boot occurs when a taxpayer receives cash or other consideration in an exchange that is greater than the equity they have in the replacement property. 

For example, let’s say an investor owns a rental property with a fair market value of $200,000 and a mortgage balance of $100,000. The investor would have $100,000 of equity in the property. If the investor sold the property and used the proceeds to purchase a replacement property for $250,000, then they would be responsible for paying the remaining $50,000 out of pocket. However, if the investor also assumed a mortgage on the replacement property for $150,000, then the total amount of cash or other consideration received in the exchange would be $200,000 – which is equal to the equity in the original property. In this case, the excess cash or other consideration would be considered equity boot.

Like mortgage boot, equity boot can have significant tax implications for investors. If you are considering an exchange, be sure to consult with a tax professional to ensure that you understand all of the potential consequences.

Important Factors to Remember for 1031 Exchange Boot

There are a few important things to keep in mind if you are considering a 1031 exchange with mortgage or equity boot:

  • Primary Requirements: In order for a 1031 exchange to qualify, the investor must reinvest the proceeds from the sale of the property into a “like-kind” replacement property. The replacement property must be of equal or greater value than the original property and must be used for business or investment purposes. 
  • Identification Period: Investors have 45 days from the date of the sale of the first property to identify potential replacement properties. 
  • Exchange Period: Investors must close on the purchase of the replacement property within 180 days of selling the original property. 
  • Taxes: Mortgage boot and equity boot can have significant tax implications for investors. Be sure to consult with a tax professional before entering into an exchange.
  • Mortgage Debt: If an investor assumes mortgage debt on the replacement property, the amount of cash or other consideration received in the exchange may be considered mortgage boot. 

Should I Hire a Professional for Help?

If you are considering a 1031 exchange, it’s important to consult with a tax professional to ensure that you understand all of the facts and requirements. Many people avoid hiring a professional because they think it will be too expensive, but the truth is that the cost of a 1031 exchange can be much higher if you don’t have the help of an expert. 

Final Thoughts

When it comes to 1031 exchanges, it’s important to be aware of all of the potential consequences before entering into one. Mortgage boot and equity boot are two concepts that you may come across during the process. 

If you are considering an exchange, remember that mortgage boot occurs when the investor receives cash or other consideration that is less than the mortgage debt assumed on the replacement property. Equity boot occurs when the investor receives cash or other consideration that is greater than the equity they have in the replacement property.