1031 exchange property

Understanding Cash Boot in a 1031 Tax Deferred Exchange

Most common questions which investors pose are around debt and cash requirements in exchange.

Can I draw some cash out of my exchange proceeds of the deal to pay off a debt or to purchase a car?

Or many exchangers aren’t aware initially that to defer all capital gains, after using the sales proceeds to pay off their relinquished property’s mortgage, they’re needed to replace it with a loan of equal or more amount. Any cash removed or debt not repaid is referred to as “boot.”  Let us understand boot in detail to ensure that you make informed decisions while identifying the replacement property and deciding on what to do with sales proceeds.

Equity And Mortgage Boot Basics

An essential 1031 exchange guidelines state that equity and debt for the replacement property in use must be equal to or greater than the said equity and debt in the original property. Net equity on a settlement statement (or cash due on the seller) follows from the gross selling price minus paid off debt, selling expenses, closing costs, and sales commissions.

If you do not purchase a replacement property of at least the same net equity value, you will end up paying taxes on the gain. The difference is called “boot,” a privilege that sellers receive either in equity or cash or as a reduction in debt or a mortgage boot. It’s crucial to understand that additional cash can offset debt here; however, additional debt doesn’t offset cash.

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