Will Receiving Cash at a Closing Invalidate a 1031 Exchange?
Many exchangers believe that they are required to reinvest all the equity from the sale of their real estate in order to do a 1031 exchange. That is not always the case. Exchangers can receive some cash, which is referred to as "boot", and may still be eligible to defer part of the gain. The first thing the exchanger should do is calculate their projected gain. The formulas for calculating a capital gain tax liability can be found in All States' website, along with a simple to use calculator.
If an Exchanger intends to perform an exchange that is fully tax deferred, they must meet two simple requirements:
(1) Reinvest the entire net equity (net proceeds) in one or more replacement properties; and
(2) Acquire one or more replacement properties with the same or a greater amount of debt.
One exception to the second requirement is that an Exchanger can offset a reduction in debt by adding cash to the replacement property closing.
If the Exchanger receives cash (or other boot) at the closing, the cash will be fully taxable to the extent of the exchanger's inherent gain. To determine the taxes that may be due, several steps are required. First, the Exchanger's tax advisor must calculate the realized capital gain. Second, the amount of boot, money or other property received, along with any depreciation recapture, must be determined. Finally, a tax advisor will review the Exchanger's specific situation to see if there are additional tax issues that may offset any current capital gain tax liabilities.
WHAT IS BOOT?
Boot is not only cash. Boot is defined as any non like kind property received by the Exchanger in the exchange and it is taxable.
Cash Boot consists of any funds received by the Exchanger, either actually or constructively. Mortgage Boot occurs when the Exchanger does not acquire debt that is equal to or greater than the debt that was paid off, therefore, they were relieved of debt. If the Exchanger does not acquire equal or greater debt on the replacement property, they are considered to be relieved of debt, which is perceived as taking a monetary benefit out of the exchange. Therefore, the debt relief portion is taxable, unless offset by adding equivalent cash to the transaction. So an Exchanger must buy of equal or greater value while spending the net (after costs) equity.