1031 Boot: How $80K Cash Out Triggers a Tax Bill

The decision: Marcus wants $80,000 in his pocket

Marcus owns a rental fourplex in Phoenix, Arizona that he is selling for $900,000. His adjusted basis is $400,000, so his realized gain is $500,000. He has claimed $180,000 of depreciation over the years. He files single, and his taxable income puts him in the 15% long-term capital-gains bracket with NIIT exposure on top.

He wants to do a 1031 exchange into a larger apartment building — but he also wants to keep $80,000 of the proceeds to renovate his primary home. The question he is really asking: if I take $80,000 out, do I blow the whole exchange and owe tax on all $500,000?

No. Under IRC §1031(b), pulling $80,000 of cash makes exactly $80,000 of his gain taxable now. The other $420,000 stays deferred. But the $80,000 is not taxed at the gentle 15% rate Marcus assumes. Because he has $180,000 of accumulated depreciation, the entire $80,000 of boot is recognized as unrecaptured §1250 gain first — taxed at 25%. His federal bill on the boot is about $20,000, plus 3.8% NIIT, plus Arizona state tax. That is the trap.

What “boot” actually means

A 1031 exchange defers tax on gain only to the extent you reinvest everything. “Boot” is the tax term for any value you receive that is not like-kind replacement property. There are two kinds:

• Cash boot. Money you walk away with — proceeds that do not get reinvested into the replacement property. This is the obvious one.
• Mortgage boot (debt relief). If the mortgage on your replacement property is smaller than the mortgage on the property you sold, the net reduction is treated as boot under Treas. Reg. §1.1031(b)-1 — even if you never touched a dollar of cash.

The governing rule is short: under IRC §1031(b), boot is taxable, but only up to the amount of your realized gain. If you receive $80,000 of boot and your gain is $500,000, you recognize $80,000. If your gain were only $30,000, you would recognize $30,000 and the rest of the boot would be a tax-free return of basis.

The order of taxation most investors get wrong

Here is the part that surprises people. When boot forces you to recognize gain, the IRS does not let you cherry-pick the lowest-taxed layer. The recognized gain comes off the top of the most-expensive layer first:

1. Depreciation recapture first. Under IRC §1250 (and §1245 for personal property), the depreciation you previously deducted is recognized before anything else. For real property, this is “unrecaptured §1250 gain,” taxed at a maximum of 25%.
2. Then long-term capital gain. Once recapture is exhausted, the remaining recognized gain is taxed at the long-term capital-gains rate — 0%, 15%, or 20% depending on your taxable income (2026: 15% applies to single filers from $48,351 to $533,400).
3. Plus the 3.8% NIIT. If your modified AGI exceeds $200,000 single / $250,000 MFJ, the net investment income tax under IRC §1411 stacks on top of whichever rate applies.

So the $80,000 boot is not a $12,000 tax bill at 15%. If Marcus has at least $80,000 of accumulated depreciation — and he has $180,000 — the whole $80,000 is recaptured at 25%, a $20,000 federal hit before NIIT and state tax. The cheap LTCG rate never even comes into play on the boot, because recapture eats the entire amount first.

The math: Marcus’s partial exchange

Marcus keeps his $80,000 and pays roughly $25,000 for the privilege — an effective rate of about 31% on the cash he pocketed once you stack recapture, NIIT, and state tax. He assumed it would cost him $12,000 at 15%. The recapture-first ordering more than doubled the bill. The $420,000 of remaining gain rides into the replacement property and stays deferred until he sells without exchanging.

Mortgage boot: the tax you can owe without touching cash

Cash boot is intuitive — you took money, you owe tax. Mortgage boot is the one that ambushes investors who thought they did a clean exchange. Under Treas. Reg. §1.1031(b)-1, if you reduce your debt in the swap, the reduction is treated as if you received cash.

Say Marcus sold a property with a $400,000 mortgage and bought a replacement with only a $350,000 mortgage, reinvesting all his cash equity. He took no cash — but he shed $50,000 of debt. That $50,000 is mortgage boot, taxable just like cash. The IRS view: relief from debt is an economic benefit identical to receiving cash and paying off the loan yourself.

The fix is mechanical. To avoid mortgage boot, your replacement property’s debt must be equal to or greater than the debt you paid off — or you must add new cash to the replacement to make up the difference. Adding $50,000 of your own cash to offset $50,000 of debt relief nets the mortgage boot to zero. (Note: cash boot and mortgage boot do not freely offset in both directions — you can use added cash to offset debt relief, but you cannot use assumed debt to offset cash you pulled out.)

What most investors miss: boot does not blow the exchange

The single most common misconception is that any boot voids the entire 1031 and makes the full gain taxable. It does not. A 1031 with boot is a partial exchange. You defer the gain on everything you reinvested and recognize gain only on the boot, capped at your total realized gain.

This means a partial exchange is a legitimate planning tool, not a failure. If you need liquidity, taking measured boot can be smarter than selling outright — you defer the bulk of the gain while accessing the cash you need. The mistake is taking boot blindly, assuming it will be taxed at the LTCG rate, and getting surprised by the 25% recapture layer.

A second myth: that you can choose to have boot taxed as capital gain instead of recapture. You cannot. The ordering under §1250 is statutory. Recapture is recognized first, full stop. The only way to avoid recapture on the boot is to take less boot than your accumulated depreciation would allow — which still hits recapture, just on a smaller number.

Three ways to control the boot before you close

• Buy up, not down. To defer 100% of the gain, your replacement property must be equal or greater in both value and equity, and you must replace or exceed your debt. Trading down in either dimension creates boot. Decide the trade-down amount deliberately, not by accident.
• Use the Qualified Intermediary correctly. Per IRC §1031, you cannot touch the proceeds — a QI holds them. If you want cash boot, instruct the QI to release that exact amount at closing. Constructive receipt of more than your intended boot can expand your taxable amount.
• Add cash to neutralize mortgage boot. If your replacement carries less debt, contribute your own cash to the purchase equal to the debt shortfall. This converts a taxable debt reduction into additional basis in the replacement property.

Boot vs. clean sale: when taking the cash still wins

The partial exchange is the middle path. Marcus pays about $25,000 (with state tax) to access $80,000 today while deferring tax on $420,000 — versus a six-figure bill if he sold outright. Whether that is the right call depends on what he does with the deferred gain: if he holds the replacement until death, the §1014 step-up wipes out the deferred gain entirely for his heirs. That is the “swap till you drop” endgame that makes deferral worth protecting.

Key takeaways

• Boot is the cash you pocket or the debt you shed in a 1031. Under IRC §1031(b) it is taxable up to your realized gain — it does not void the exchange, it makes it partial.
• An $80,000 cash boot on a $500,000 gain means $80,000 of recognized gain and $420,000 still deferred. You only lose deferral on the dollars you walked away with.
• Recapture is recognized FIRST. The first dollars of boot are taxed at the 25% unrecaptured §1250 rate, not the 15% LTCG rate — which is why boot costs roughly double what investors expect.
• Mortgage relief is boot too. Under Treas. Reg. §1.1031(b)-1, buying down your debt is taxed like cash unless you add equal cash to the replacement.
• The lever: decide your boot deliberately. Buy equal-or-greater in value and debt for full deferral, or take measured boot for liquidity — just price it at the recapture rate, plus 3.8% NIIT and state tax, before you sign.