Boot

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).

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.

 Boot can result from a variety of factors. It is important for a taxpayer to understand what can result in boot if taxable income is to be avoided. The most common sources of boot include the following:

• Cash boot taken from the exchange. This will usually be in the form of "net cash received", or the difference between cash received from the sale of the exchange property and cash paid to acquire the replacement property or properties. Net cash received can result when a taxpayer is "trading down" in the exchange so that the replacement property does not cost as much as the exchange property sold for.

• Debt reduction boot which occurs when a taxpayer’s debt on replacement property is less than the debt which was on the exchange property. As with cash boot, debt reduction boot can occur when a taxpayer is "trading down" in the exchange.

• Sale proceeds being used to pay service costs at closing which are not closing expenses. If proceeds of sale are used to service non-transaction costs at closing, the result is the same as if the taxpayer received cash from the exchange, and then used the cash to pay these costs. Taxpayers are encouraged to bring cash to the closing of the sale of their property to pay for the following non-transaction costs:

· Rent proration.

· Utility escrow charges.

· Tenant damage deposits transferred to the buyer.

· Any other charges unrelated to the closing.

• Excess borrowing to acquire replacement property. Borrowing more money than is necessary to close on replacement property will cause cash being held by an Intermediary to be excessive for the closing. Excess cash held by an Intermediary is distributed to the taxpayer, resulting in cash boot to the taxpayer. Taxpayers must use all cash being held by an Intermediary for replacement property. Additional financing must be no more than what is necessary, in addition to the cash, to close on the property.

• Loan acquisition costs with respect to the replacement property which are serviced from exchange funds being brought to the closing. Loan acquisition costs include origination fees and other fees related to acquiring the loan. Taxpayers usually take the position that loan acquisition costs are being serviced from the proceeds of the loan. However, the IRS may take a position that these costs are being serviced from Exchange Funds. This position is usually the position of the financing institution also. There is no guidance in the form of Treasury Regulations on this issue at the present time which is helpful.

• Non-like-kind property which is received from the exchange, in addition to like-kind property (real estate). Non-like-kind property could include the following:

• Seller financing, promissory note.

• Sprinkler equipment acquired with farm land.

• Ditch stock in a mutual irrigation ditch company acquired with farm land (possible issue).

• Big T Water acquired with farm land (possible issue).

Acquisition of ditch stock or Big T water is a possible issue with the IRS. Most taxpayers report their exchanges of farm land by taking the position that water on the farm land is indistinguishable from, and the same thing as real estate. The IRS has been known to have a different view.

Boot Offset Rules - Only the net boot received by a taxpayer is taxed. In determining the amount of net boot received by the taxpayer, certain offsets are allowed and others are not, as follows:

• Cash boot paid (replacement property) always offsets cash boot received (exchange property).

• Debt boot paid (replacement property) always offsets debt-reduction boot received (exchange property).

• Cash boot paid always offsets debt -reduction boot received.

• Debt boot paid never offsets cash boot received (net cash boot received is always taxable).

Exchange expenses (transaction and closing costs) paid (exchange property and replacement property closings) offset net cash boot received.

 Rules of Thumb Regarding Boot

Always trade "across" or up. Never trade down. Trading down always results in boot received, either cash, debt reduction or both. The boot received can be mitigated by exchange expenses paid.

Bring cash to the closing of the Exchange Property to cover charges which are not transaction costs (see above).

Do Not receive property which is not like-kind.

Do Not over-finance replacement property. Financing should be limited to the amount of money necessary to close on the replacement property in addition to exchange funds which will be brought to the replacement property closing.

Basis and Depreciation Consideration

The basic concept of a 1031 exchange is that the basis of your old property passes to your replacement new property. In other words, if you sold your old property for $100,000, and bought your replacement new property for the same, your basis on the replacement new property would be the same. It makes sense then that your depreciation schedule would be exactly the same. It is. In other words, one continues the depreciation calculations as if one continues to own the old property (the acquisition date, cost, previous depreciation taken, and remaining un-depreciated basis remain the same).

For additional depreciation a property purchase above the minimum replacement property purchase for complete tax deferral is required.

One may have an interest deduction for replacement property borrowed funds.

1031 FEC recommends your experienced 1031 exchange and personal tax advisor to confirm your tax advantages.

Sale of Residence (Does not qualify for a 1031 Exchange)

You may qualify to exclude from your income all or part of any gain from the sale of your main home. Your main home is the one in which you live most of the time.

Ownership and Use Tests

To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

• Owned the home for at least two years (the ownership test)
• Lived in the home as your main home for at least two years (the use test)

Gain

If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).

• If you can exclude all of the gain, you do not need to report the sale on your tax return
• If you have gain that cannot be excluded, it is taxable. Report it on Schedule D (Form 1040)

Loss

You cannot deduct a loss from the sale of your main home.

Worksheets

Worksheets are included in IRS Publication 523, Selling Your Home, to help you figure the:

• Adjusted basis of the home you sold
• Gain (or loss) on the sale
• Gain that you can exclude

Reporting the Sale

Do not report the sale of your main home on your tax return unless you have a gain and at least part of it is taxable. Report any taxable gain on IRS Schedule D (Form 1040).

More Than One Home

If you have more than one home, you can exclude gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.

Example One:

You own and live in a house in the city. You also own a beach house, which you use during the summer months. The house in the city is your main home; the beach house is not.

Example Two:

You own a house, but you live in another house that you rent. The rented house is your main home.

Business Use or Rental of Home

You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the ownership and use tests.

Example:

On May 30, 1997, Amy bought a house. She moved in on that date and lived in it until May 31, 1999, when she moved out of the house and put it up for rent. The house was rented from June 1, 1999, to March 31, 2001. Amy moved back into the house on April 1, 2001, and lived there until she sold it on January 31, 2003. During the 5-year period ending on the date of the sale (February 1, 1998 - January 31, 2003), Amy owned and lived in the house for more than 2 years as shown in the table below.

Amy can exclude gain up to $250,000. However, she cannot exclude the part of the gain equal to the depreciation she claimed for renting the house.

Contact 1031 FEC for tax saving alternatives when selling a home with gain above exclusion allowed.

For Personal Property - Aircraft - Watercraft - Valuable Animal - Equipment tax saving alternatives contact 1031 FEC.