Selling property is never as simple as handing over the money and getting the deed of sale. For a variety of legal and economic reasons, taxation plays a critical role in 1031 land exchanges and other real estate transactions, primarily because the value of the property will always shift depending on how the land is used. This, in turn, can affect the local businesses and economy, which makes it important that such exchanges always be taxed.
This leads to something called a cash boot, a commonly used but not legally defined area of buying any type of property. It’s often a necessary arrangement in land exchanges, but can often cost the landowner quite a bit—and they may even incur these charges without their knowledge.
Defining the boot
A “boot” is the term used for other things that a party gives in a land or property exchange to make the declared value of the goods even. While it’s possible to find like-kind properties that you can cleanly exchange, doing so in today’s market is often very difficult. For properties or lands that need to be acquired within a timeframe, most parties would generally settle for a boot of some kind in order to facilitate an equal exchange of value.
Boots can take a variety of forms, though the most common one is cash. Other forms of boots can be the debts, liens, mortgages, outstanding liabilities, or ongoing developments to the land or property that the seller promises to make to the buyer.
The reason keeping an eye on your boot is important is that while the base amount of your exchange can be tax-deferred, any sort of boot is considered income and, therefore, can be taxed. As it is classified a taxable gain, there stands a risk of losing your profit margin if you are forced to resort to a boot in order to equalize the value of the exchange.
How can I get the boot?
There are several ways of getting the boot and knowing what exactly can result in a boot is important if the buyer is looking to avoid as much taxable income as possible.
- Cash exchange. If the properties traded are unequal in value, “net cash received” will often apply as a boot. This often happens when the price of the property replaced is less than that of the property that has been sold.
- Money from the sale being used to pay for non-qualified expenses. If a significant portion of the property’s revenue is being used to pay for things such as closing fees, it falls under taxable gains.
- Debt reduction. If one or both of the properties involved are still under a mortgage, the difference in their outstanding debt can often be classified as taxable gains.
For the reasons outlined above, it’s important to always pay for the property via the base amount that you’ve provided in order to avoid the boot. Not only does this help you avoid additional taxation by the IRS; it can also allow you to set the terms of how you will deal with any outstanding obligations you may have acquired along with the property.
