Mortgage boot is one of the two most common types of boot encountered in a 1031 exchange. The other common type of boot is cash boot.
It’s a rare thing to encounter another type of boot in an exchange. In technical lingo, boot is any property received as consideration in an exchange which is not of a like-kind to the relinquished property.
Today, because of the change made by the TCJA, this means any personal property received will constitute boot. If a taxpayer receives $50,000 of stock on top of their sale, then he or she will have “stock boot”.
Clients often have questions about mortgage boot because it’s common to see existing loans on relinquished property.
Clients are often confused about mortgage boot because they tend to assume that Section 1031 is primarily about spending their cash as opposed to deferring capital gain.
In this post, we will discuss in detail the phenomenon of mortgage boot and give a couple of examples which can be used to shed light on this issue.
Mortgage Boot Equals Debt Relief
Suppose a client has a rental property which has a $250,000 mortgage loan. For those who own rental properties, this is a very common scenario.
Further suppose that the client manages to secure an offer for $600,000. If we omit closing costs, the client would be left with $350,000 following the sale.
In this scenario, many clients simply assume that only this remaining $350,000 needs to be spent in order to achieve full tax deferral.
While this perception may seem reasonable, it misses the purpose of Section 1031. In this scenario, even if the taxpayer has $350,000 of cash remaining after paying off the mortgage, he or she also has “debt relief” because the mortgage was paid off using capital gains from the sale.
In other words, the client has settled the loan by using the gains which are meant to be deferred in the 1031 exchange.
If the client was able to simply pay off the mortgage and then achieve full tax deferral by spending the remaining funds, he or she would have a dual benefit not conceived by Sec. 1031…
Continue reading the article and learn more about mortgage boot on Enre Real Estate website.