Any Boot Received in Addition to Like Kind Replacement Property Will be Taxable (to the extent of gain realized on the exchange). This is okay when a seller desires some cash or debt reduction and is willing to pay some taxes. Otherwise, boot should be avoided in order for a 1031 Exchange to be completely tax-free.

The term "boot" is not used in the Internal Revenue Code or the Regulations, but is commonly used in discussing the tax consequences of a Section 1031 tax-deferred exchange. Boot received is the money or the fair market value of "other property" received by the taxpayer in an exchange. Money includes all cash equivalents plus liabilities of the taxpayer assumed by the other party, or liabilities to which the property exchanged by the taxpayer is subject. "Other property" is property that is non-like-kind, such as personal property received in an exchange of real property, property used for personal purposes, or "non-qualified property." "Other property" also includes such things as a promissory note received from a buyer (Seller Financing).

A Rule Of Thumb for avoiding "boot" is to always replace with property of equal or greater value than the relinquished property. Never "trade down." Trading down always results in boot received, either cash, debt reduction or both. Boot received is mitigated by exchange expenses paid. See The Rules of Boot in a Section 1031 Exchange for a detailed explanation of these rules.

The Basic Types of 1031 Exchanges

A Simultaneous Exchange is an exchange in which the closing of the relinquished property and the replacement property occur on the same day, usually back-to-back. There is no interval of time between the two closings. This type of exchange is covered by the safe harbor Regulations.

A Delayed Exchange is an exchange where the replacement property is closed on at a later date than the closing of the relinquished property. The exchange is not simultaneous or on the same day. This type of exchange is sometimes referred to as a "Starker Exchange" after the well known Supreme Court case in which ruled in the taxpayer's favor for a delayed exchange before the Internal Revenue Code provided for such exchanges. There are strict time frames established by the Code and Regulations for completion of a delayed exchange, namely the 45-Day Clock and the 180-Day Clock (see detailed explanation below). Delayed exchanges are covered by the safe harbor Regulations.

A Reverse Exchange (Title-Holding Exchange) is an exchange in which the replacement property is purchased and closed on before the relinquished property is sold. Usually the Intermediary takes title to the replacement property and holds title until the taxpayer can find a buyer for his relinquished property and close on the sale under an Exchange Agreement with the Intermediary. Subsequent to the closing of the relinquished property (or simultaneous with this closing), the Intermediary conveys title to the replacement property to the taxpayer. The IRS has issued new safe harbor guidance on Reverse Exchanges.

An Improvement Exchange (Title-Holding Exchange) is an exchange in which a taxpayer desires to acquire a property and arrange for construction of improvements on the property before it is received as replacement property. The improvements are usually a building on an unimproved lot, but also include enhancements made to an already improved property in order to create adequate value to close on the Exchange with no boot occurring. The Code and Regulations do not permit a taxpayer to construct improvements on a property as part of a 1031 Exchange after he has taken title to property as replacement property in an exchange. Therefore, it is necessary for the Intermediary to close on, take title and hold title to the property until the improvements are constructed and then convey title to the improved property to the taxpayer as replacement property. Improvement Exchanges are done in the context of both Delayed Exchanges and Reverse Exchanges, depending on the circumstances. The IRS has issued new safe harbor guidance on Reverse Exchanges (including title-holding exchanges for construction or improvement).

Delayed 1031 Exchanges - The Exchange Process and Time Clocks

A taxpayer desiring to do a 1031 Exchange lists and/or markets his property for sale in the normal manner without regard to the contemplated 1031 Exchange. A buyer is found and a contract to sell the property is executed. Accommodation language is usually placed in the contract securing the cooperation of the buyer to the seller's intended 1031 Exchange, but such accommodation language is not mandatory.

When contingencies are satisfied and the contract is scheduled for a closing, the services of an Intermediary are arranged for. The taxpayer enters into an Exchange Agreement with the Intermediary which permits the Intermediary to become the "substitute seller" in accordance with the requirements of the Code and Regulations.

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