1031 Exchange FAQ - BOOT

YES! Believe it or not. Many people don't know or even realize them, some pros may not know it as well.

It is possible, in a 1031 exchange, to recognize gain even if not one cent of boot is received! There’s a little-known rule that can cause you to trigger the entire recapture as ordinary income even if you do not recognize gain figured under the regular exchange rules. Recapture income will be recognized if the fair market value of the depreciable property you receive in the exchange is less than the income subject to recapture. The amount of gain recognized is limited to the difference between the depreciation subject to recapture and the value of the depreciable property.

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In a 1031 exchange, you can still have a even if you have no boot at all! Very few know this rule but it is possible to to trigger the entire recapture as ordinary income even if you do not recognize gain figured under the regular exchange rules. Recapture income will be recognized if the fair market value of the depreciable property you receive in the exchange is less than the income subject to recapture. The amount of gain recognized is limited to the difference between the depreciation subject to recapture and the value of the depreciable property.

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In a 1031 exchange, you can still have a even if you have no boot at all! Very few know this rule but it is possible to to trigger the entire recapture as ordinary income even if you do not recognize gain figured under the regular exchange rules. Recapture income will be recognized if the fair market value of the depreciable property you receive in the exchange is less than the income subject to recapture. The amount of gain recognized is limited to the difference between the depreciation subject to recapture and the value of the depreciable property.

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Yes. There is an ingenious tax strategy which will permit you to take back boot in a 1031 exchange without paying tax on it now. The Gain from the boot can be deferred into future tax years. It's done by taking back a purchase money installment note from the “buyer” of the Relinquished Property to balance all or part of the equities. When structured correctly, the taxable gain in the note may be reported using the installment method of tax accounting.

If you are an exchange specialist, be sure to tell your clients about this marvelous tax saving strategy. They will love you for it—all the way to the bank.

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Yes. It is possible to deduct from your boot the costs to market your 1031 Exchange property at the time of closing of sale.

When working out the numbers for their 1031 exchange, many tax-payers, real estate pros and investory, overlook the selling expenses as an offset against boot received. Factoring in this offset is critical when the exchange is originated and in the planning stages. Selling expenses paid in connection with a 1031 exchange are treated as cash boot paid and offsets any boot received. Selling expenses include brokerage commissions and other closing costs such as title policy fees, escrow fees, and recording fees.

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In a 1031 Exchange, sometimes among the qualified like-kind Real Estate that is being traded, other items are included with bargain. Items that are not like-kind are considered un-like which can include money, gold, silver, foreign currency, airplanes, motor homes, precious stones and real estate to be used as your personal residence.

All Money and unlike property received in the exchange is boot and is taxable. You can easily compute your boot this way:

Figure out the amount of money received plus the fair market value of unlike property received.

An example would be: You exchange real estate for other real estate plus you receive $10,000 cash and securities with a fair market value of $25,000. Total boot received by you is $35,000.

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In a 1031 Exchange, any cash taken back from your sales proceeds is considered boot. The IRS wants you to re-invest these proceeds in your replacement property but since you are taking control over these proceeds, you are expected to pay taxes on them as capital gains and/or regular income. So the answer to this questions, is YES, cash as boot IS considered taxable income.

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In a 1031 Exchange, all unlike property that is also traded is considered boot. Boot is the same as cash. If you take back boot outside of the 1031 Exchange Period (the time when your Qualified Intermediary is holding your proceeds) the funds are subject to the Capital Gains Tax and treated as income. If you take boot during the 1031 Exchange period, you may pay the Capital Gains tax on the entire 1031 Exchange Proceeds because taking boot during the 1031 Exchange Period will collapse your Exchange and cause it to fail.

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Yes and no.

In a 1031 Exchange, if you receive no cash or property boot in the exchange, but you have net mortgage relief, you may offset sales expenses paid against your net mortgage relief. If the offset creates a “loss”, the Code bars any deduction.

You should also remember that your Loss is not deductable.

However, if the sale of the personal property had resulted in a loss, the loss would be deductible as an ordinary loss since the nonrecognition of gain or loss provision of §1031 does not apply to unlike property.

The gain or loss is the difference between your adjusted basis in the property and your amount realized. The fair market value is considered to be your amount realized.

For example, as part of an exchange you give unlike property with a cost of $1,000. The fair market value of the property at the time of the exchange is $1,500. You will recognize a $500 gain.

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Many real estate agents and investors when working out the numbers for their real estate exchange often overlook selling expenses as an offset against boot received. Factoring in this offset is critical when the exchange is originated and in the planning stages. Selling expenses paid in connection with a 1031 exchange are treated as cash boot paid and offsets any boot received. Selling expenses include brokerage commissions and other closing costs such as title policy fees, escrow fees, and recording fees.
If you receive no cash or property boot in the exchange, but you have net mortgage relief, you may offset sales expenses paid against your net mortgage relief. If the offset creates a “loss”, the Code bars any deduction.

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Nearly all boot is taxable. Many taxpayers forget that all of the costs that went in to selling your 1031 Exchange property are offset against any of the boot that you have received. If you have $10k in boot but it cost $11k to sell your property, you would have boot but none of it would be taxable because the $11k to sell your property would be written off. More reading about Boot can be found here!

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Our 1031 Exchange Knowledge Base article says it best:
"Money and unlike property in an exchange is called boot. To figure your taxable gain, determine the fair market value of the boot you receive. Then figure how much your gain would have been if you had sold the property as a regular taxable sale instead. Your taxable gain is the smaller of these two amounts.
If the other party assumes any of your liabilities as part of the exchange, you will be treated as if you received boot in the amount of the liability."

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A 1031 Exchange is the continuation of your property investment when you exchange like-kind properties for the purpose of deferring your Capital Gains Tax to a future sale. Boot is the cash or non like-kind property portion in a 1031 Exchange. 1031 Exchange is not called boot, though there are portions of a 1031 Exchange that are considered boot. Remember, that receiving boot in a 1031 Exchange is a taxable event, subject to Capital Gains or ordinary income.

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We have a complete write on all the aspects of boot including the liability in our 1031 Exchange Knowledge Base. You can review the article your self at http://www.realtyexchangers.com/1031_Exchange_Information_Center/Topic_3_-_Figuring_Boot_and_Taxable_Gain.php#Topic 3 - Figuring Boot and Taxable Gain, or by clicking here.

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Answer: As you qualified intermediary, we are holding your proceeds for one specific purpose, so that you can purchase a replacement property and complete your 1031 Exchange. We can give you proceeds back anytime you wish and for whatever purpose, but if the goal is  1031 Exchange, there are some IRS rules to follow.

1. You can take back proceeds, called "boot receivable" at the time your Relinquished Property closes. These funds are subject to Capital Gains and are deducted from your proceeds BEFORE they are transferred to your Qualified Intermediary.

2. Soon as you Identify your properties (within 45 days of the sale of your relinquished property), you have 180 days to close sale on them. The IRS states that you cannot access any of your proceeds until ALL of your identified properties have closed sale.

Any access to your proceeds during the 180 day period prior to closing on your identified replacement properties could negate your entire 1031 exchange, which means your entire proceeds could be subject to the Capital Gains Tax.

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Question:  After we close on my relinquished property, how soon can I access my proceeds.

Answer: As you qualified intermediary, we are holding your proceeds for one specific purpose, so that you can purchase a replacement property and complete your 1031 Exchange. We can give you proceeds back anytime you wish and for whatever purpose, but if the goal is  1031 Exchange, there are some IRS rules to follow.

1. You can take back proceeds, called "boot receivable" at the time your Relinquished Property closes. These funds are subject to Capital Gains and are deducted from your proceeds BEFORE they are transferred to your Qualified Intermediary.

2. Soon as you Identify your properties (within 45 days of the sale of your relinquished property), you have 180 days to close sale on them. The IRS states that you cannot access any of your proceeds until ALL of your identified properties have closed sale.

Any access to your proceeds during the 180 day period prior to closing on your identified replacement properties could negat

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When you close sale on your Relinquished property the proceeds need to be kept in a safe harbor with a Qualified Intermediary (Realty Exchangers). During your exchange period your proceeds can ONLY be used to purchase qualified 1031 Exchange Replacement Properties. Any withdrawal of your funds could negate your 1031 Exchange when the IRS reviews your file.

You have two opportunities to access your proceeds and not jeopardize your exchange.

The first is when you close sale on your Relinquished property. At that time you make take a portion of the proceeds back for your own use. This called Boot Receivable and is subject to Capital Gains Tax. The remaining funds from your sale should be transferred as your proceeds into your Qualified Intermediary's (Realty Exchangers) client trust account.

The second is after you have closed sale on all of your Identified Replacement Properties before the 180 day deadline. These left-over proceeds are also subject to capital gains tax.

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Yes! Realty Exchangers, Inc., regularly manages these types of transactions and knows the correct procedure that must be followed to assure §1031 Exchange treatment. The installment note and related documents are made out in the name of the QI (Qualified Intermediary). There are four choices on how to use it to buy replacement property:

You can use it to acquire Replacement Property by trading it to the "Seller " for part of the consideration for purchase of new property. This does not trigger the unrecognized gain in the installment note.
You can instruct the QI to sell the note on the open market (you can negotiate this sale or have the QI do it as your agent) and add the amount realized to the exchange proceeds. This will give you all cash to negotiate your replacement purchase. It's less desirable because of the discount you might have to give on the sale of the note. This does not trigger the unrecognized gain in the installment note.
A party related to you, the exchanger, such as a closely held corporation or relative can either purchase the installment note from your QI or provide financing so that your QI receives all cash at closing. You should consult with your tax advisor regarding structuring this type of transaction. This does not trigger the unrecognized gain in the installment note.
You can wait until the end of the exchange and receive the installment note back from the QI. This will result in the note becoming "boot" and it will be taxable. However, at this point the installment sale rules under §453 kick in and you are permitted by election to use the installment method of tax accounting and only recognize capital gain as you collect principal payments each year. Interest on the installment note is always taxable at ordinary income rates. Your installment sale percentage for figuring gain will be 100%.

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Your 1031 Exchange Proceeds are available to you at any time. The fact that we are holding your money as your Qualified Intermediary does not mean you cannot have access to it. But in order to take advantage of deferring your Capital Gains tax, there are only a couple of times when you can access your proceeds without danger of collapsing your 1031 Exchange. When you close sale on your Relinquished Property (the property you are selling) you may take back proceeds known as "boot received". These funds may be used however you see fit, just know that they will be subject to Capital Gains Tax. The other time you may access your proceeds without putting your 1031 Exchange in danger is after the sale closes on your final identified replacement property. As with "boot receivable" your remaining unspent proceeds are also subject to the capital gains tax.

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Sometimes you may find it necessary to pay for a 1031 Exchange Replacement Property in a form other than cash.  Be very careful here: KNOW WHAT YOU ARE SELLING. The name for what you use to purchase a Replacement Property is called boot. If you use anything other than the proceeds from your Relinquished property, it can be taxable.

Any boot you give (payment in part consideration of the Replacement Property) is treated as a straight sale of the boot. The tax-free provisions of §1031 do not apply to boot you transfer in the exchange. If you give money, no gain or loss to you is recognized on the money you give. However, if you give boot in property other than money, a gain or loss will be recognized. The transaction is treated as a sale of the unlike property and the regular gain and loss tax rules apply.

The gain or loss is the difference between your adjusted basis in the property and your amount realized. The fair market value is considered to be your amount realized. For example, as part of an exchange you give unlike property with a cost of $1,000. The fair market value of the property at the time of the exchange is $1,500. You will recognize a $500 gain.

If the personal property was business property (§1245), the gain would be treated as ordinary income to the extent of depreciation taken, and might be taxed as ordinary income.

If the sale of the personal property had resulted in a loss, the loss would be deductible as an ordinary loss since the nonrecognition of gain or loss provision of §1031 does not apply to unlike property.

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If at the end of your 180 day 1031 Exchange period, the replacement property is not completed, the builder can deed over the property "as is" (before the 180-days) and the cost of the property at that time will count as qualified property of like-kind. Any costs added after that date will count as boot received. If you are "trading up", then it is possible the cost at the time of transfer will be more than enough to qualify you for a full 1031 benefit. It's a matter of crunching the numbers and it's always a good practice to consult your CPA.

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Old time 1031 Exchange gurus use the term "napkin test" to describe the basic rule that all cash proceeds from the sale of the Relinquished Property must be “reinvested” in the Replacement Property to avoid recognized taxable gain from the exchange. If you trade up, and all the cash is “reinvested”, no taxable boot. But if you trade down, and all the cash is not “reinvested”, the net cash back to you is treated as cash boot received and recognized as taxable gain.

However, there is an adjustment to cash boot received not realized by many when the exchange is originated and in the planning stages. Selling expenses paid in connection with a §1031 exchange are treated as cash boot paid and offsets any boot received. Selling expenses include brokerage commissions and other closing costs such as title policy fees, escrow fees, and recording fees. This means you can trade down by the amount of your selling expenses paid and still have no recognized gain. Here is an example of this vital tax-planning tool.

You sell your Relinquished Property and the cash proceeds total $135,000. Your selling expenses total $32,000 of which you paid $10,000 outside of escrow. The balance of the selling expenses or $22,000 was paid through escrow and the net proceeds of $113,000 are paid into your QI’s trust account. At this point, your net cash boot received is $103,000 and this is the amount you need to “reinvest” to avoid net boot received and taxable income.

Selling Expenses are all expenses directly related to the sale of the Relinquished Property and is the amount used by IRS to deduct from the Selling Price to figure the Adjusted Sales Price. Selling expenses do not include interest, points, taxes, fixing up expenses, repairs, insurance, operating expenses of the property, personal bills or impound account adjustments. Occasionally selling expenses are paid outside of escrow. For example, a consulting fee paid in connection with the transaction may qualify as a selling expense. Be sure to check with your tax professional if you have any questions regarding your particular selling expenses. See Chapter Four for more discussion of this important topic.

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Yes, if there is any depreciation subject to recaptured (Section 1250) at the time of the 1031 exchange, no recapture takes place if there is no gain recognized on the exchange - it is carried forward and attaches to the replacement property. If there is gain recognized because of net boot received, the first gain recognized is the ordinary income from the recapture. If the total gain is more than the ordinary income from recapture, the balance is capital gain.

Example - Your Relinquished Property shows a recapture of excess depreciation in the amount of $30,000 at the time of the exchange. You trade up and no gain is recognized. The $30,000 is carried over into the Replacement Property and not recognized as gain at the time of the exchange. However, if you trade down and take - say - $25,000 boot, then the entire $25,000 gain will be recognized as ordinary income and $5,000 will carry over to your Replacement Property. If you took back - say - $40,000 boot, the entire $30,000 would be recognized as ordinary income and $10,000 would be recognized as capital gain.

Caution: This rule only applies if the substituted basis of the Replacement Property is more than the amount of recapture. If you exchanged for land only - there is no depreciable real estate to carry it over to. In this case, all the recapture amount of $30,000 would trigger and be recognized even though you took no boot at all.

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