Mortgage Boot

Mortgage boot, also called debt-relief boot, is the taxable amount that arises in a 1031 exchange when the debt paid off on the relinquished property exceeds the debt taken on (or cash added) for the replacement property. The IRS treats relief from a liability as the economic equivalent of receiving cash, so a net reduction in mortgage debt is recognized as gain even though the investor never receives a dollar in hand. For example, if the sold property carried a $400,000 loan and the replacement is financed with only $250,000, the investor has $150,000 of mortgage boot unless that gap is offset. The two ways to cure mortgage boot are to take on new debt of equal or greater amount on the replacement property, or to contribute additional out-of-pocket cash equal to the shortfall. Notably, the netting rules are asymmetric: paying cash into the exchange offsets debt relief, but taking cash out cannot be cured by adding more debt. Because mortgage boot is easy to trigger inadvertently when trading down in leverage, investors pursuing full deferral should model their debt replacement carefully with their qualified intermediary and CPA before closing.