How to calculate 1031 Boot Taxes

Poway, CA · Member since 2017 · 15 posts · 2 votes

Hello everyone,

We have been searching the posts here on BP and still haven't really found a specific answer to our question. How do you calculate tax on a 1031 Boot? Here's our situation: We sold one property and are buying 5. We may need to drop one of the 5 and want to know what the tax consequences are. We need specific numbers and a calculation we can use to decide whether we keep the property and pay the possible $35K in repair costs or use the purchase price/cost to invest in something else that was not listed on our 1031 (since we will be paying CG taxes anyway). Basically, we need to know if the boot taxes would be less than the repair costs of the property.

Thanks in advance for your help!

Karen

1 Reply

215 views

Most Popular Reply

Nicholas AiolaBusiness Member

CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes

@Dave Foster @Aaron Smith @Wayne Brooks @Karen Seale @Bill B.

Boot from a 1031 exchange is treated the same as if you sold the rental property outright. Therefore, suspended passive activity losses (PALs) do, indeed, offset boot from a 1031 exchange.

Who doesn't love tax-free cash?!

As Dave mentioned, suspended PALs don't directly offset capital gain from the sale of a rental property by way of netting the capital gain to zero; rather, they are reported separately but in an offsetting fashion. In other words, capital gain is reported in full (which will be included on Schedule D) and passive losses equal to that gain will be reported separately (which will be included on Schedule E), ultimately bringing the net effect to zero, if there are enough suspended and current PALs to do so. The net effect won't be zero if PALs < boot/capital gain.

This goes for both long- and short-term holding periods assuming, as Dave said, the intent on short-term holdings was to hold onto the property for productive use.

Finally, I side with Dave's accountant with respect to taxing boot as capital gain first, as opposed to depreciation recapture. You will get differences of opinion on this depending on which tax pro you speak to.

In my research and experience, I've yet to come across clear-cut guidance on this topic; if anyone has, please share and margaritas are on me.

Aiola CPA, PLLC551 Reviews

Website View Page

4 Reply

See this reply in the discussion

28 Replies

Jump to latestLatest

Sort by

Lance LvovskyPro Member
Accountant · Fort Lauderdale, FL · Member since 2013 · 1k+ posts · 753 votes
8y
Have you asked your CPA to run the calculation for you? 1031 exchanges are not simple and you should seek the advice from your CPA.
0 Reply
Eric B.
Accountant · St. Petersburg, FL · Member since 2015 · 6 posts · 17 votes
8y
There isn’t nearly enough information presented here to even begin to start that calculation. When dealing with 1031 exchanges there is no easy formula where you can just plug and chug a few numbers and have your answer. Especially when multiple properties are involved. You need to consult with and pay your CPA to run the numbers.
2 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Karen SealeThankfully there is no fancy footwork here. The boot is simply considered to be part of the gain that you are taking and will simply be taxed as it normally would if you weren't doing a 1031.
In order to defer all tax you must purchase at least as much as you sell and use all of your proceeds. So any amount you buy less than what you sell or any amount of cash you receive is simply considered to be profit (boot).
I've put a gain calculator that will let you play with partial exchange scenarios at www.the1031investor.com.
The 1031 Investor5137 Reviews
Website View Page
2 Reply
Karen Seale
OP
Poway, CA · Member since 2017 · 15 posts · 2 votes
8y
@ Lance Lvovsky, @ Eric B, and @ Dave Foster - thank you all so very much for your input. We were hoping for a "quick" answer as our CPA does not work on the weekend and we needed an answer asap due to time constraints for multiple variables involved.
@ Dave- I will check out your calculator and thank you again!
0 Reply
Bill B.
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
8y
@Dave Foster
@Karen Seale
Karen, did you identify exactly 5 for your 1031? if you identified 5 properties (or any number more than 3) did you follow the other specific rules for the 1031 exchange in situations where you identify more than 3? I included Dave as he can simply tells us the answer as opposed to me guessing.
Dave does that come in to play as well? Identifying more than 3 and not buying them all?
0 Reply
Karen Seale
OP
Poway, CA · Member since 2017 · 15 posts · 2 votes
8y
@Bill Brant, @ Dave Foster
We identified 7 properties (initially 5 and added 2 for "in case" scenarios) and followed all the rules of the exchange. Of the 5, one was cancelled and so we made an offer on 1 of 2 from our back ups. The 2nd back-up is now pending by another buyer so is not available. If we lose the 5th property (not good inspection/way too many things found), will we be paying CG on the $168K for that one property or for the whole 1031 amount ($925K)?
I hope I am providing enough info.
Karen
0 Reply
Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
8y
You simply pay taxes on the “short fall” of what you didn’t reinvest.....whether that be unused cash or a smaller replacement purchase price. Not sure, but I think you pay depreciation recapture first, then cap gains.
Margarita Boy @Dave Foster, will know.
1 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Bill B., If @Karen Seale names more than 3 properties then their aggregate value can't exceed 200% of what she sold. That impacts whether she can do an exchange or not. But it wouldn't impact the gain recognized from boot. If their sale was $925 then that list of potential properties can't exceed 1,850,000. But in order to defer all tax they would still have to purchase at least $925K. If what you're saying Karen is that the total of the four property purchased is $757K and you still have $168K to purchase and that's what may not happen then you would pay tax on the $168K difference only as @Wayne Brookssaid and would shelter the rest of whatever tax was in that
The 1031 Investor5137 Reviews
Website View Page
0 Reply
Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
8y
@Dave Foster For my own education, which you’ve already contributed to......when there is boot as perhaps above, do you have to pay back all the depreciation recapture first, or is it divided up and prorated with cap gains?
0 Reply
Bill B.
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
8y
@Wayne Brooks
GOOD QUESTION!
0 Reply
Karen Seale
OP
Poway, CA · Member since 2017 · 15 posts · 2 votes
8y
@Wayne Brooks - Yes! That is the question indeed. We have contacted our CPA and hopefully we can get an answer in the next day or 2 so we can make a decision before our due diligence is up.
Thank you, thank you everyone! I am grateful for this conversation and your input. This seems to be an area of investing we can all learn a thing or two about. :-)
0 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Wayne Brooks,@Bill B.,@Karen Seale, That is the only variable (whether that boot is taxed at depreciation recapture or capital gain or ordinary income). There isn't a clear guidance and I've seen it both ways. Obviously the difference between taxed as ordinary income or capital gain is going to be your length of hold.
But what about whether it should be taxed as depreciation recapture or gain first? Like I said I have seen accountants do it both ways My own thoughts and personal choice has been to always treat it as profit first. Here's why, My intent in doing a 1031 is to carry forward the basis of my old property. So if I happen to fall short I'm simply taking some of the profit and that profit should be taxed as capital gain. In my mind there's no symmetry or logic in taking boot but calling it depreciation recapture. I can see why I'd like to take some profit out of a deal. But I doubt I'd ever want to raise my adjusted basis by recapturing depreciation. Fortunately my accountant agrees :) So if I take boot I take profit first and pay the appropriate capital gains tax.
The 1031 Investor5137 Reviews
Website View Page
0 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Wayne Brooks does that mean margaritas are on you? :)
The 1031 Investor5137 Reviews
Website View Page
0 Reply
Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
8y
@Dave Foster 😎
0 Reply
Aaron Smith
Investor · Washington, DC · Member since 2016 · 175 posts · 73 votes
8y
@Dave Foster I’m wondering, if you have suspended passive losses, this will offset the portion of the boot that is taxable, no?
0 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
8y
@Aaron Smith, An accountants question so I'll let them verify but I don't think you can use passive losses to offset capital gain. Where the question is interesting is if you sold a property and 1031d it but had not owned it for a year. Your intent must have been to hold for productive use. But if you met that intent and then decided to sell and do the 1031 it might be a different thing.
Boot from a 1031 with a shorter hold like that would be taxed at ordinary income rate which in my mind would make it passive income and could be offset by with passive losses.
Calling CPAs????
The 1031 Investor5137 Reviews
Website View Page
0 Reply
Nicholas AiolaBusiness Member
CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes
8y
@Dave Foster @Aaron Smith @Wayne Brooks @Karen Seale @Bill B.
Boot from a 1031 exchange is treated the same as if you sold the rental property outright. Therefore, suspended passive activity losses (PALs) do, indeed, offset boot from a 1031 exchange.
Who doesn't love tax-free cash?!
As Dave mentioned, suspended PALs don't directly offset capital gain from the sale of a rental property by way of netting the capital gain to zero; rather, they are reported separately but in an offsetting fashion. In other words, capital gain is reported in full (which will be included on Schedule D) and passive losses equal to that gain will be reported separately (which will be included on Schedule E), ultimately bringing the net effect to zero, if there are enough suspended and current PALs to do so. The net effect won't be zero if PALs < boot/capital gain.
This goes for both long- and short-term holding periods assuming, as Dave said, the intent on short-term holdings was to hold onto the property for productive use.
Finally, I side with Dave's accountant with respect to taxing boot as capital gain first, as opposed to depreciation recapture. You will get differences of opinion on this depending on which tax pro you speak to.
In my research and experience, I've yet to come across clear-cut guidance on this topic; if anyone has, please share and margaritas are on me.
Aiola CPA, PLLC551 Reviews
Website View Page
4 Reply
Karen Seale
OP
Poway, CA · Member since 2017 · 15 posts · 2 votes
8y
@Nicholas Aiola -
That is a very nice explanation and concurs with what our CPA said as well. Thank you for taking the time to give such concise feedback!
Cheers,
Karen
1 Reply
John Hunter
Member since 2019 · 7 posts · 6 votes
7y
Originally posted by @Nicholas Aiola:
...
Finally, I side with Dave's accountant with respect to taxing boot as capital gain first, as opposed to depreciation recapture. You will get differences of opinion on this depending on which tax pro you speak to.
In my research and experience, I've yet to come across clear-cut guidance on this topic; if anyone has, please share and margaritas are on me.
Here is an example
net sales price      $750,000
adjusted basis $450,000 (which has been reduced by $50,000 in depreciation)
mortgage    $400,000
That gives a gain of $300,000 (made up of $250,000 in cap gains and $50,000 in depreciation recapture)
and cash of $350,000
With no 1031 attempt the tax situation would be
capital gain of $250,000 and $50,000 in recaptured depreciation (ordinary income)
With this 1031 example would it then be
New property
full cost     $400,000
cash down $100,000
mortgage $300,000
capital gains of $250,000
because you are talking $250,000 "out" ($350,000 in cash less $100,000 in cash down on the new place) you have to treat that cash you get as taxable profit first and only after than has been used up then as return of basis. The $50,000 of depreciation on the old house would roll into the new one (leaving a basis of $350,000).
But if the
New property was
full cost $400,000
cash down $250,000 with a $150,000 mortgage
you are now just taking $100,000 out ($350,000 less $250,000 down on the new place) and so could reduce the gains to
capital gain of $100,000
with the new place having the basis reduced by $200,000 ($150,000 capital gain and $50,000 depreciation) leaving a $200,000 cost basis.
Is it that you essentially have to pay tax on whatever you take out (until you have taken out your entire profit plus depreciation)?
0 Reply
Bill B.
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
7y
Props to @Nicholas Aiola for actually answering a question as a CPA rather than the 1 sentence answers so common in BP....
“Ask your cpa”
“Sell all your rentals if you aren’t going to treat it like a business...”
Etc...
Thanks again Nicholas for adding so much to BP.
3 Reply
Mark Creason
Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes
7y
@John Hunter
A couple of points to add before all the smart guys respond. Depreciation recapture is taxed at 25%, not as ordinary income. You can have cash or mortgage boot, which is taxed as profit first. If you have a net 100k property sale, with a 50k adjusted basis, and a 60k mortgage, you would need to find a replacement property for at least 100k, with at least 40k in cash (sale proceeds) in order to defer all taxes. If you had this scenario and only bought a 40k replacement with the 40k in cash, you would have mortgage boot of 60k, owing taxes on 50k first. Hope this helps.
0 Reply
Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
7y
Great discussion all!
Just want to clarify my understanding of the tax rate on the 'recapture' portion that @Mark Creason mentioned. I *think* that the recapture portion is taxed at either 1)your ordinary income tax rate OR 2) 25%, whichever is lower.
Meaning if you are only in the 12% tax bracket it would be 12%, if you were in the 25% it would be 25%, and if you were in the 37% bracket it would still be the max rate for recapture of 25%.
The one thing I am NOT clear in is how if affects things if the amount of recapture, or capital gains for that matter, 'take you over' a tax bracket amount? Meaning if you have 57K of taxable income and are in the 12% tax bracket, and you have 20K of additional recapture or capital gains, that takes you up to top of the bracket at 77K. I think capital gains would be 0% and recapture 12% at that point. What happens if your capital gain or recapture is 40K instead of 20K, and it takes you 20K 'into' the next tax bracket? Does half of it get taxed at the lower rate and half at the higher, similar to ordinary income? Or does it ALL go into that higher bracket?
Thanks, Dan Dietz
[email protected]608-524-4899
0 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@John Hunter - ..."Is it that you essentially have to pay tax on whatever you take out (until you have taken out your entire profit plus depreciation)?: that's it!
Any amount you purchase less than your sale or any amount of cash you take out is seen as a way of taking profit. If you buy less than you sell it's called "mortgage boot". If you take cash it's called "cash boot".
So if you buy $300K less than what you sell in a 1031 and you have a total gain of $350K consisting of $250 K profit and $100K depreciation recapture then you will pay tax on $300K of gain. $250 of it will be capital gain (if it qualifies) and $50K will be depreciation recapture. You will still shelter the other $50K of depreciation recapture in the 1031.
The 1031 Investor5137 Reviews
Website View Page
3 Reply
John Hunter
Member since 2019 · 7 posts · 6 votes
7y
Originally posted by @Dave Foster:

@John Hunter - ..."Is it that you essentially have to pay tax on whatever you take out (until you have taken out your entire profit plus depreciation)?: that's it!
Any amount you purchase less than your sale or any amount of cash you take out is seen as a way of taking profit. If you buy less than you sell it's called "mortgage boot". If you take cash it's called "cash boot".
So if you buy $300K less than what you sell in a 1031 and you have a total gain of $350K consisting of $250 K profit and $100K depreciation recapture then you will pay tax on $300K of gain. $250 of it will be capital gain (if it qualifies) and $50K will be depreciation recapture. You will still shelter the other $50K of depreciation recapture in the 1031.
Thanks for your reply. It seems my focus on cash though is missing the "mortgage boot."
So in my 2nd example, where on a cash basis you only "take out" $100,000 ($350,000 cleared on the sale less $250,000 down on the new place) and on a cash basis can you can just take $100,000 capital gain and $250,000 reduces the basis of the new place.
But I am not clear on the "mortgage boot" - if you sell a place with a $400,000 mortgage and buy with a $250,000 mortgage does that mean you have a $150,000 mortgage boot? Since it is called a "mortgage boot" am I correct in thinking it only has to do with the mortgage and not the cost of the new place (in my example the first place cleared $750,000 and the 2nd place only cost $400,000 which is a $350,000 difference).
1 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@John Hunter, It really has nothing to do with the mortgage specifically (although it's called mortgage boot).
Easiest to start with the understanding that your 1031 exchange reinvestment requirement is really two requirements. In order to defer all tax you must purchase at least as much as your net sale. And you must use all of the net proceeds from the sale in the purchase.
Any amount of cash you take out is seen as taking profit (cash boot).
Any amount that you purchase less than you sold is seen as taking profit (mortgage boot).
You pay tax on the difference but shelter whatever remaining profit is left.
Technically you do not have to actually replace mortgage debt with mortgage debt. You can infuse cash from any other source (think of this as replacing your debt by borrowing from yourself if that helps). Most people do not have access to outside cash so they replace mortgage for mortgage. But the bottom line is as long as you purchase at least as much as you sell and as long as you use all the proceeds you pay no tax.
Any amount you purchase less than you sell or any amount of cash you pull out is taxable until you've pulled out (or bought less) an amount equal to your entire gain (profit + depreciation). Cash you take or amount you purchase less are the variables you can play with to determine your taxability.
The 1031 Investor5137 Reviews
Website View Page
1 Reply

Join the conversationCreate a free account to reply, vote on answers and follow this thread.