Rental Property 1031 Exchange & Boot

Question

Is a mortgage "boot" still considered a recognized gain even if the debt, LTV (loan to value) and purchase price have all increased or remained the same in the exchange?

Note: If you aren't familiar with the term "boot" see example below.

The question may appear simple, but even the most simple example is still complicated. Here is an example that is very close to real life:

1. Purchase a property for $165,000 ($132,000 debt/loan) - 80% LTV

2. 4 years later: 1031 Exchange
   Sell original property for $280,000 -/minus approx 3% in fees = $271,000
   Remaining Mortgage $123,000
   Net Proceeds are: $148,000

3. Purchase Exchange property for $280,000 ($224,000 debt/loan) - 80% LTV
   Down Payment is $56,000
   Net Proceeds (boot) after down payment: $92,000

To repeat the question for the example: is the $92,000 "boot" considered a recognized gain and taxable? ie. would it need to be part of the down-payment (thus a final loan of $132k just like the original loan) in order to be safe from capitol gains tax? What if the purchase price was even greater, yet there was still a boot? ie. is boot always considered a recognized gain?

Answer 1

According to https://finance.zacks.com/transfer-capital-gains-new-property-8920.html

You can use Section 1031 to transfer all capital gains to a new property if the exchange is pure and money does not change hands. Or, you can transfer a portion of capital gains to new property if, in addition to an exchange of property, you also receive a sum of money. In this case you will need to pay tax on the money you receive.

The $92k of equity that you withdrew will be taxed. Since your capital gain was ($271k-$165k) = $106k, the exchange has deferred (but not eliminated) an unrealized gain in the amount of ($106k - $92k) = $14k -- your basis in the new property will be only $266k.