You did everything right and still owe tax.
Every deadline met, every form filed, the replacement closed on day 140. And a tax bill shows up anyway. The word for what happened is boot, and it is the most common way an otherwise clean exchange turns out to be only partly deferred.
Boot is anything you walk away with that isn’t like-kind property.
A 1031 defers gain only to the extent you actually exchange one investment property for another. Anything you receive that is not replacement real estate is boot, and boot is taxable up to the amount of gain you had.
That last clause matters. Boot does not create tax out of nowhere. It makes your existing gain taxable, dollar for dollar, up to the amount of boot you received. If you had $400,000 of gain and took $60,000 of boot, roughly $60,000 becomes taxable and the rest stays deferred. The exchange is not destroyed. It is partial.
Which is genuinely good news, and also why boot goes unnoticed until a CPA is preparing the return. Nothing dramatic happens at closing. There is no warning. The deal looks like a success right up until the number appears.
Cash boot is obvious. Mortgage boot is the one that surprises people.
Money that reaches you instead of the replacement
Proceeds you keep rather than reinvest. Sometimes deliberate, often not: leftover funds after the replacement closes, a seller credit, or simply buying something cheaper than what you sold.
Debt relief counts as money received
Sell a building with an $800,000 mortgage and buy one with a $500,000 mortgage, and the $300,000 of debt you no longer owe is treated as though someone handed it to you. Paying off debt feels like prudence. The code treats it as proceeds.
New cash can absorb debt relief
Bringing outside cash into the purchase can offset mortgage boot. The reverse does not work: taking cash out is not cured by taking on more debt. The asymmetry catches people who assume the two net against each other freely.
Non-transaction costs paid from proceeds
Ordinary closing costs generally come out of exchange funds without creating boot. Other items paid at the closing table — certain prorations, security deposits, some fees — can. This is detail work, and it is exactly the sort of detail that gets settled at a closing table by people not thinking about your return.
Buy a replacement of equal or greater value, reinvest all of your net proceeds, and replace the debt you had with equivalent debt or with new cash. Satisfy all three and boot generally does not arise. Miss any one of them and it does.
Four ordinary decisions that create it.
None of these look like tax mistakes when you make them. They look like normal, even careful, real-estate decisions.
Trading down because the numbers looked better
A smaller building with stronger cash flow can be the right investment and still generate boot. The difference between sale price and purchase price is taxable. Worth doing with the number in front of you rather than discovering it in April.
Paying off the mortgage because you could
Reducing leverage is usually sound. Inside an exchange it produces mortgage boot unless you offset it with cash. This is the single most common source of an unexpected bill.
Leaving a little on the table
Proceeds left over after the replacement closes come back to you and are taxable. On a large sale, “a little” is rarely little. Modelling the replacement price before you identify avoids this entirely.
Pulling cash out to fund the renovation
The replacement needs work, so you keep some proceeds to pay for it. That cash is boot. An improvement exchange, where the work happens while the property is still parked, is the structure built for this exact situation.
What people actually ask.
Does boot ruin the whole exchange? +
Can I take a small amount of cash out on purpose? +
Does paying off my mortgage really count as income? +
Do closing costs create boot? +
How do I know my number before I commit? +
Find your boot before the closing, not after.
Bring us the sale price, the existing mortgage and what you are thinking of buying. Twenty minutes and you will know what stays deferred, what does not, and what you would have to change to move that number. Including when the honest answer is that a small amount of boot is worth accepting.