Mortgage relief is taxable boot
When you sell a property with a $600,000 mortgage and buy a replacement with only a $400,000 mortgage, you have been relieved of $200,000 in debt. The IRS treats that $200,000 as cash boot received — taxable in the year of the exchange to the extent of your gain. Boot can come from two sources: actual cash you pocket from the exchange, and net debt relief (old debt minus new debt). Both are added together to determine your taxable boot.
You can offset mortgage relief boot by paying additional cash into the replacement. If old debt was $600,000 and new debt is $400,000, putting in an extra $200,000 of your own cash zeroes out the net boot. What you cannot do is the reverse: excess cash invested in the replacement does not create a credit you can apply to cash you receive.
Net boot formula
Net boot = (cash received from sale + old debt assumed by buyer) − (cash paid toward replacement + new debt taken on). If this number is positive, you have taxable boot. Example: sell for $1,000,000 with $400,000 mortgage (equity $600,000), buy for $900,000 with $350,000 mortgage, pay $50,000 additional cash. Net boot = ($0 cash received + $400,000 old debt) − ($50,000 cash paid + $350,000 new debt) = $450,000 − $400,000 = $0. No boot — all the debt relief was covered by additional cash and a small reduction in equity.
If instead you had paid no additional cash and took on only $350,000 in new debt: Net boot = $400,000 − $350,000 = $50,000 taxable.
Practical planning tips
To achieve a fully deferred exchange, ensure you: (1) reinvest all net equity from the sale into the replacement, (2) take on equal or greater debt in the replacement, or (3) compensate for any debt reduction with additional cash. Work with your qualified intermediary early in the process — they can model the boot calculation before you close and identify whether you need to adjust the financing structure of the replacement to avoid an unexpected tax bill.
Frequently asked questions
What is mortgage relief boot in a 1031 exchange?
It is the taxable amount that arises when you pay off more debt than you take on in the replacement. Reducing your loan balance by $200,000 is treated the same as receiving $200,000 in cash.
Can I use extra cash to offset mortgage boot?
Yes. If old debt exceeds new debt, you can contribute additional cash to the replacement to eliminate the net debt relief boot. The cash offsets the mortgage reduction dollar-for-dollar.
What if I want to pay off my mortgage entirely in the exchange?
Paying off the old mortgage and buying the replacement free-and-clear creates full mortgage-relief boot equal to the old loan balance, unless you compensate with equivalent cash. This would make the full deferred gain taxable.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.