A 1031 tenant-in-common (TIC) exchange seems like the perfect solution to minimize your tax burden when selling your property. Though it is, there are many pitfalls you should avoid to benefit from the deferred taxes in this transaction. One of these pitfalls is a 1031 exchange boot.
Exchange boots comprise all items in your transaction that don’t meet the set requirements of a “like-kind” under the IRS tax code. Experts from 1031 Exchange Place explain any boot included in your 1031 TIC exchange will attract capital gain taxes. Here are the three common boots:
This comes about if you buy a property with a lesser mortgage compared to the one you’ve relinquished. In this case, the difference between the mortgage of your relinquished and replacement properties will be taxed. To avoid this, you can add cash to reduce the mortgage on your property before selling. This way, your replacement property will have a debt greater than or equal to that of your relinquished one.
This refers to the net cash in your transaction. A cash boot may come about if you buy your replacement property for less than what you sold your property for. It also follows receipt of promissory notes, repair charges and other costs not related to closing expenses. Any net cash in your exchange is liable for capital gains tax.
Personal Property Boot
This occurs if your property sale includes other assets apart from real estate. These are usually appliances, equipment, and inventory. The proceeds from these items result in capital gains tax liabilities. You can avoid personal property boot by planning with your buyer beforehand to handle these assets separately.
These types of boots can significantly affect your 1031 exchange and see you end up with considerable tax liabilities. It’s a must to have all the closing statements from your transaction reviewed by a qualified intermediary so you can identify all likely boot sources.