Partial 1031 Exchange: How Boot From Cash and Debt Is Taxed

What counts as boot?

Section 1031 defers gain only to the extent you receive like-kind property. Anything else you receive in the exchange is "boot," a word from the old phrase "to boot," meaning something thrown in on top. Under §1031(b), gain is recognized up to the fair market value of the boot. You never recognize more than your realized gain, and boot doesn't create a loss.

There are three kinds:

• Cash boot. Money you receive, or money that's used for your benefit. Sale proceeds you take out of the exchange, funds left in the QI account at the end, and exchange money used to pay non-exchange costs all count.
• Mortgage boot (debt relief). When the buyer of your property pays off or takes over your loan, the regulations treat that relief as money you received. Treasury Regulation §1.1031(d)-2 says liabilities assumed by the other party, or liabilities the property is subject to, are treated as money received.
• Other property. Non-like-kind property you receive in the exchange. Since 2018, §1031 applies only to real property, so furniture, equipment, a car, a note from the buyer or personal property in a sale are boot. There's a narrow allowance in Reg. §1.1031(k)-1(g)(7) for incidental personal property that comes with replacement real property and is worth no more than 15% of the real property, but that rule is about the safe harbors, and personal property you receive can still be taxable.

Most partial exchanges I see involve the first two. Owners either want some cash out, or they buy a replacement with less debt than they had, often without realizing that the debt counts.

How do you calculate boot? The rule of thumb and the real math

The rule of thumb for a fully tax-deferred exchange has two parts:

1. Buy replacement property with a value equal to or greater than the net sale price of what you sold.
2. Reinvest all of your net cash proceeds.

If you do both, you'll replace at least as much debt as you paid off (or you'll cover the shortfall with added cash), and you won't have boot. The rule of thumb fails in edge cases, so here's the actual calculation, step by step:

1. Realized gain = sale price − selling costs − adjusted basis.
2. Cash boot received = cash you receive from the exchange, including leftover funds and exchange money used for non-exchange costs.
3. Net mortgage boot = debt paid off or assumed by the buyer − debt you take on or assume in the replacement − cash you add from outside the exchange. If the result is negative, it's zero.
4. Total boot = cash boot + net mortgage boot + fair market value of other property received.
5. Recognized gain = the lesser of total boot and realized gain.
6. Deferred gain = realized gain − recognized gain.
7. Replacement basis = replacement property cost − deferred gain.

Notice what step 3 allows and what it doesn't. The netting goes one way. That's the most misunderstood rule in partial exchanges, so it gets its own section.

Why does cash offset mortgage boot but not the other way around?

The regulations let consideration you give offset liability relief you receive. They don't let liabilities you take on offset cash you receive.

Treasury Regulation §1.1031(d)-2 has an example with two apartment owners, D and E, who swap buildings. D's building has an $80,000 mortgage; E's has a $150,000 mortgage; and D also receives $40,000 in cash from E. Here's how each side comes out:

• D is relieved of $80,000 of debt and takes on $150,000. The liabilities offset, so D has no net mortgage boot. But D still received $40,000 in cash, and taking on more debt doesn't offset it. D recognizes $40,000 of gain.
• E is relieved of $150,000 of debt, takes on $80,000, and pays $40,000 in cash. E's net debt relief is $70,000, and the $40,000 E paid offsets it, leaving $30,000 of boot. E recognizes $30,000.

In practice:

• You can fix mortgage boot by adding cash. If you pay off a $900,000 loan and only take a $700,000 loan on the replacement, adding $200,000 of your own money to the purchase eliminates the $200,000 of mortgage boot.
• You can't fix cash boot by adding debt. If you take $200,000 out of the exchange, borrowing an extra $200,000 on the replacement doesn't cure it. The cash is boot.

The logic: if new debt could offset cash out, anyone could borrow against the replacement, keep the sale proceeds, and defer tax on what amounts to a cash sale. The regulation blocks that.

Worked examples

All of these use the same starting point. These are hypothetical examples with made-up numbers, not real clients.

Say you sell a fourplex in Oakland for $2,400,000. Selling costs (commission, escrow, title, transfer tax) are $120,000. You owe $900,000 on the loan, which is paid off at closing. You bought it years ago, and after $500,000 of depreciation your adjusted basis is $800,000.

• Amount realized: $2,400,000 − $120,000 = $2,280,000
• Realized gain: $2,280,000 − $800,000 = $1,480,000
• Net cash to your QI: $2,280,000 − $900,000 = $1,380,000

To defer all $1,480,000, you need to buy at least $2,280,000 of replacement property, reinvest all $1,380,000, and take on at least $900,000 of debt or add outside cash to make up any shortfall.

Example 1: Cash boot

You want $200,000 for a down payment on a vacation home. You buy a $2,300,000 replacement property with $1,180,000 of exchange money and a $1,120,000 loan, and the remaining $200,000 comes to you.

• Cash boot: $200,000
• Mortgage boot: $900,000 paid off − $1,120,000 new debt = negative, so $0
• Total boot: $200,000
• Recognized gain: $200,000 (less than the $1,480,000 realized gain)
• Deferred gain: $1,280,000
• Replacement basis: $2,300,000 − $1,280,000 = $1,020,000

Notice that you bought a more expensive building with more debt than you had before, and you still have $200,000 of taxable gain. The extra $220,000 of debt doesn't offset the cash you took.

Example 2: Mortgage boot

You reinvest all $1,380,000 but buy a smaller $2,000,000 property with a $620,000 loan.

• Cash boot: $0
• Mortgage boot: $900,000 − $620,000 = $280,000
• Recognized gain: $280,000
• Deferred gain: $1,200,000
• Replacement basis: $2,000,000 − $1,200,000 = $800,000

This is the surprise I see most often. The owner reinvested every dollar of cash and still has $280,000 of taxable gain, because the replacement carries less debt and the price is below the $2,280,000 net sale price.

You can check the basis another way: old basis $800,000 + gain recognized $280,000 + new debt $620,000 − debt relieved $900,000 = $800,000. Both methods agree.

Example 3: Fixing mortgage boot with added cash

Same as Example 2, but instead you buy a $2,280,000 property. You use all $1,380,000 of exchange money, take a $620,000 loan, and bring $280,000 of your own cash.

• Mortgage boot before offset: $900,000 − $620,000 = $280,000
• Less cash you added: $280,000
• Net mortgage boot: $0
• Recognized gain: $0
• Replacement basis: $2,280,000 − $1,480,000 = $800,000

Adding cash solved the problem completely. If you'd rather keep your cash, the alternative is a bigger loan: a $900,000 loan on the same $2,280,000 property works too.

Example 4: Both kinds of boot at once

You take $100,000 in cash and buy a $2,000,000 property with $1,280,000 of exchange money and a $720,000 loan.

• Cash boot: $100,000
• Mortgage boot: $900,000 − $720,000 = $180,000
• Total boot: $280,000
• Recognized gain: $280,000
• Deferred gain: $1,200,000

The boot types stack. The netting rule only lets cash you add offset debt relief; it doesn't let the $720,000 loan reduce the $100,000 of cash you received.

Which part of the gain gets taxed first?

This is where partial exchanges get more expensive than people expect. When you recognize part of your gain, the IRS doesn't treat it as a slice of the whole. Depreciation-related gain comes out first.

There are two layers to understand.

Section 1245 recapture. If your property includes components depreciated as personal property, typically from a cost segregation study (carpet, fixtures, certain site improvements), the depreciation on those components is §1245 property. Section 1245(b)(4) limits recapture in a like-kind exchange, but recognized gain attributable to those components is ordinary income, taxed at your ordinary rates (up to 37% federally in 2026, plus the 3.8% net investment income tax for many investors). The One Big Beautiful Bill Act restored 100% bonus depreciation for qualifying property acquired after January 19, 2025, so owners who did cost segregation recently may have more §1245 exposure than they realize. The limit in §1245(b)(4) only shelters that recapture to the extent you acquire §1245 property in the exchange, so if your replacement property doesn't include enough personal property of its own, you can owe ordinary-income recapture even on an exchange with no cash or mortgage boot. A cost-segregated building needs its own analysis before you sell it.

Unrecaptured §1250 gain. For buildings placed in service after 1986 and depreciated on a straight-line basis, there's generally no ordinary-income recapture under §1250. But the gain attributable to the depreciation you took is "unrecaptured §1250 gain," taxed at a maximum federal rate of 25% instead of 20%.

In a partial exchange, the prevailing practice, which follows from how §1250(d)(4) and the definition of unrecaptured §1250 gain in §1(h)(6) work, is that recognized gain is treated as unrecaptured §1250 gain first, up to the depreciation taken, and only then as capital gain taxed at up to 20%. The depreciation you don't recognize now carries over to the replacement property.

Back to Example 2. You recognized $280,000, and you'd taken $500,000 of depreciation. If none of the depreciation was §1245 property, all $280,000 is unrecaptured §1250 gain:

If the gain were taxed proportionally at the 20% capital gains rate, the federal capital gains tax would be $56,000 instead of $70,000. The ordering costs you an extra $14,000 here, before state tax. In California, add state income tax at ordinary rates, because California doesn't have a lower capital gains rate.

The 25% figure is a maximum. If your taxable income is lower, some unrecaptured §1250 gain can be taxed at your ordinary rate when that's below 25%. Your CPA will compute the actual figure on the Schedule D worksheet.

My view: if you plan to take cash out of an exchange, assume the first dollars of gain are taxed at the 25% rate plus 3.8%, plus state tax. Planning on 20% is the most common way owners underestimate a partial exchange.

When does a partial exchange make sense on purpose?

Plenty of owners intend to take some cash, and I think that's a reasonable decision when the math supports it. An exchange doesn't have to be all-or-nothing. A few situations where I've seen it make sense:

• You need cash and the alternative is worse. If you need $300,000 for a business, a child's home purchase or a tax bill, a partial exchange taxes only that $300,000 (at most) while the rest of the gain stays deferred. Selling outright would tax the whole gain.
• You're trading down and can't find enough property. If the replacement market won't give you something you want at the full price, taking boot on the difference can be better than overpaying for a building you don't want.
• You want to lower your debt. Some owners near retirement want less debt on purpose. Mortgage boot is the price of that, and it may be worth paying.

How to take cash out with less tax

There are a few ways to structure it, each with tradeoffs.

Take the cash at the front. You can receive some proceeds at the closing of the relinquished property, before the rest goes to the QI. This is clean and the amount is fixed. The rest of the money goes into the exchange.

Take what's left at the end. If you identify more than you buy, or end with leftover funds, you receive them when the exchange agreement allows. Under Reg. §1.1031(k)-1(g)(6), the QI generally can't release funds until the end of the 45-day identification period (if you identified nothing), until you've acquired everything you identified, or until the end of the 180-day exchange period. Cash at the end is still boot, but you've kept the option to use it.

Use the installment method when the exchange straddles two years. If you sell in, say, November and the exchange period runs into the next year, Reg. §1.1031(k)-1(j)(2) can let you report cash boot received in the second year in that year, under the installment method, provided you had a bona fide intent to complete the exchange. That defers the tax on the boot by a year. Your CPA should confirm you qualify.

Refinance the replacement property later. Instead of taking cash out of the exchange, some owners complete a full exchange and later refinance the replacement property. Loan proceeds aren't income. Practitioners generally view refinancing the replacement property after the exchange as lower risk than refinancing the relinquished property right before the sale, which the IRS can view as taking cash out of the exchange in disguise. Timing, an independent business reason and the loan's terms all matter here, so get advice before you do it.

A refinance has its own cost: more debt and a higher payment. Whether that beats paying tax on the boot depends on the interest rate, your cash flow and your plans for the property.

What about California?

If the property you're selling is in California, your QI generally must withhold California income tax at 3⅓% when boot exceeds $1,500, unless an exemption applies or you elect the alternative withholding method based on gain using Form 593. If the exchange fails completely, withholding applies to the full sale price. The withholding is a prepayment, not the final tax.

California also tracks deferred gain when you exchange California property for out-of-state property. You file Form 3840 each year until you sell the replacement property in a taxable sale, and California taxes the deferred California gain at that point.

How can DSTs help replace debt?

Mortgage boot is a common problem for owners who want to simplify. You sell a building with a large loan, and you don't want a new loan you're personally on the hook for. Delaware Statutory Trusts are one way people deal with that.

A DST that owns financed property carries a loan placed by the sponsor before you invest. The loan is usually non-recourse to investors, meaning the lender looks to the property, not to you personally, except for standard carve-outs that usually fall on the sponsor. Because the IRS treats a properly structured DST as a grantor trust under Revenue Ruling 2004-86, each investor is treated as owning a share of the property, subject to a share of the debt. That share of the debt generally counts toward replacing the debt you paid off.

Here's how the math works with the fourplex. You have $1,380,000 of exchange money and need to replace $900,000 of debt and reach $2,280,000 of total value. Suppose you want part of it in a debt-free DST and part in one with a loan.

• Put $880,000 into a hypothetical DST with no debt. Value acquired: $880,000. Debt: $0.
• Put $500,000 into a hypothetical DST with a 65% loan-to-value ratio. Your equity is 35% of your share of the property, so your share of the property is $500,000 ÷ 0.35 = $1,428,571, and your share of the debt is $928,571.

Totals: $2,308,571 of property and $928,571 of debt. Both exceed what you need ($2,280,000 and $900,000), so you have no mortgage boot and no cash boot. These figures are hypothetical and do not represent any actual offering.

You can split across more than one offering to hit both targets, but I'd caution against working backward from the boot math. The debt in a DST is real debt. It magnifies losses as well as gains, and the trust's limited ability to deal with it is a real risk:

• A DST trustee generally can't take on new borrowing or renegotiate the loan except in limited situations such as a tenant's bankruptcy or insolvency. If the loan matures in a weak market, the sponsor may have to sell, convert the trust to an LLC (losing some of the tax features investors relied on), or ask investors for decisions they didn't expect.
• Higher loan-to-value ratios leave less room before a drop in value wipes out equity.
• Distributions can be reduced or suspended to cover debt service.

Replacing debt with a high-LTV DST to avoid $280,000 of boot only makes sense if you'd want that investment anyway. If the boot tax is about $80,000 federally plus state tax, and the debt adds risk you aren't comfortable with, paying the tax may be the better choice. That's the kind of tradeoff I'd rather show you plainly than steer you around.

How the boot calculator works

The boot calculator on this page follows the seven steps in this guide. You enter:

• Sale price of the relinquished property
• Selling costs paid from the proceeds (commissions, title, escrow, transfer tax)
• Loan balance paid off at closing
• Adjusted basis, and total depreciation taken
• Purchase price of the replacement property (or properties combined)
• New debt on the replacement property, including your share of debt in any DST
• Cash you'll add from outside the exchange
• Cash you'll receive, or exchange funds you expect to leave unspent

It calculates your realized gain, cash boot, mortgage boot before and after the cash-added offset, total boot, recognized gain (the lesser of total boot and realized gain), deferred gain, and the starting basis of the replacement property. It then splits the recognized gain into unrecaptured §1250 gain (up to the depreciation you entered) and remaining capital gain, and applies federal rates you can adjust, with defaults of 25%, 20% and the 3.8% net investment income tax, plus a state rate you enter.

It doesn't handle §1245 recapture from cost segregation, personal property received, the installment method, multiple relinquished properties with different bases, related-party rules, or state-specific items like California withholding and Form 3840. Treat its output as a starting point for a conversation with your CPA, not a tax return.

What mistakes create boot by accident?

These are the patterns I see most often:

• Forgetting that debt counts. Owners reinvest all the cash, buy something cheaper, and don't realize the lower loan creates mortgage boot. Example 2 is the most common version.
• Paying non-exchange costs from exchange funds. Loan fees, rent prorations and security deposits paid from the exchange account can create cash boot. I go through which costs are which in 1031 Exchange Costs and Fees.
• Reimbursing yourself. Paying a deposit out of pocket and then taking it back from exchange funds at closing is cash to you.
• Buying the replacement for less than the net sale price "because the cash is all reinvested." If the price is lower and the cash is all in, the debt went down, which is mortgage boot.
• Paying off unrelated debt from the sale. Using sale proceeds to pay off a credit line or a loan on a different property is cash used for your benefit.
• Taking back a note from the buyer. A seller-carry note is boot unless it's structured so the note goes to your QI and is sold or collected inside the exchange. Plan that before the contract is signed.

Risks and limitations

If you use a DST or another securities offering in an exchange, including to replace debt, you take on risks a direct property doesn't have, along with some it does:

• Illiquidity. DST interests generally have no public market. Expect to hold for years with no assurance of an early exit.
• Loss of principal. Property values can fall, and you can lose some or all of your investment. Debt makes this more likely in a downturn.
• Distributions are not guaranteed. They may be paid, but they can be reduced or suspended.
• Debt and refinancing risk. DSTs generally can't add or renegotiate debt except in limited circumstances, which can force a sale or restructuring at a bad time.
• Reliance on the sponsor. You don't control management, leasing, the sale or its timing, and the sponsor may have conflicts of interest.
• Fees and load. Upfront and ongoing fees reduce the equity working in real estate and the cash that reaches you.
• Tax risk and law change. The treatment of DSTs under Revenue Ruling 2004-86, the boot and recapture rules, and §1031 itself can change. A failed exchange is taxable.

DST interests are offered only to accredited investors through a private placement memorandum, which describes the specific risks and fees.

The examples here are simplified, and your facts will differ. This isn't tax or legal advice; confirm your numbers with a CPA or tax attorney and your qualified intermediary before you close.

Frequently asked questions

Is boot taxed as ordinary income or capital gain?

Usually as capital gain, but at layered rates. Recognized gain is generally treated first as unrecaptured §1250 gain up to the depreciation you've taken, taxed at a maximum federal rate of 25%, then as long-term capital gain at up to 20%. Gain tied to §1245 property, often from cost segregation, is ordinary income. Many investors also owe the 3.8% net investment income tax, and states like California tax all of it at ordinary rates.

Can I take cash out of a 1031 exchange and still defer most of the tax?

Yes. That's a partial exchange. You owe tax on the cash you take (up to your realized gain), and the rest of the gain stays deferred as long as you reinvest the remaining proceeds in like-kind property within the deadlines. Expect the first dollars of recognized gain to be taxed as depreciation-related gain at up to 25% federally. Taking cash at the front of the exchange, at the relinquished closing, is the simplest way to do it.

Do I have to replace my mortgage in a 1031 exchange?

Not literally, but you have to replace the value. If your replacement debt is lower than the debt you paid off, the difference is mortgage boot unless you add outside cash to make it up. So you can buy all-cash, as long as you add enough of your own money to cover the debt you didn't replace and the purchase price still matches or exceeds your net sale price.

Can I add more debt to offset cash I take out?

No. Under Treasury Regulation §1.1031(d)-2, liabilities you take on offset liabilities you're relieved of, and cash you pay offsets liability relief, but new debt doesn't offset cash you receive. If you take $150,000 out of the exchange, the $150,000 is boot even if your new loan is $500,000 larger than your old one.

What happens to the money left over after I buy my replacement property?

It stays with your QI until the exchange agreement and Reg. §1.1031(k)-1(g)(6) allow its release: generally after you've acquired all the property you identified, or after the 180-day exchange period ends. When it's released, it's cash boot, taxable up to your realized gain. If the exchange crosses two tax years, the installment rules may let you report it in the year you receive it.

Does boot affect the basis of my replacement property?

Yes. Your replacement basis equals the replacement cost minus the gain you deferred. Recognizing some gain through boot means less gain is deferred, so your basis in the replacement is higher than it would have been in a full exchange. In Example 1 above, the $200,000 of cash boot raised the replacement basis by $200,000 compared with a full deferral.

Can I use a DST to avoid mortgage boot?

A DST's built-in non-recourse debt generally counts toward replacing the debt you paid off, because investors are treated as owning a share of the property subject to a share of the loan. That makes DSTs one tool for owners who want to replace debt without signing a new loan. The debt still adds risk, DSTs have limited ability to refinance, and the offering's fees reduce your equity. It's worth doing only if you'd want the investment anyway.

Is there a minimum amount of boot that isn't taxed?

No. Any boot is taxable up to your realized gain; there's no threshold below which boot is ignored. Small amounts of boot often come from closing costs or prorations paid from exchange funds. The tax on a few thousand dollars may be small, but it's still reportable on Form 8824.

If you're weighing a partial exchange, I'm glad to run the boot and recapture math with you on your actual numbers, and you can request access to the investor portal to see how I evaluate replacement options.

Sources

• 26 U.S.C. §1031, Exchange of real property held for productive use or investment (Cornell LII)
• 26 CFR §1.1031(d)-2, Treatment of assumption of liabilities (Cornell LII)
• 26 CFR §1.1031(k)-1, Treatment of deferred exchanges (Cornell LII)
• 26 U.S.C. §1250, Gain from dispositions of certain depreciable realty (Cornell LII)
• 26 U.S.C. §1(h), Maximum capital gains rate, including unrecaptured section 1250 gain (Cornell LII)
• IRS Instructions for Form 8824, Like-Kind Exchanges
• IRS Revenue Ruling 2004-86, Delaware statutory trusts (Internal Revenue Bulletin 2004-33)
• California Franchise Tax Board, Qualified intermediary withholding
• PG Calc, Indexed Tax Tables for 2026