The two numbers you have to match
Almost everyone thinks a 1031 exchange means reinvesting their profit. It doesn't. There are two separate tests and you have to pass both.
Match the value. Your replacement property has to cost at least as much as your relinquished property sold for, net of selling costs.
Reinvest all the equity. Every dollar that went to your qualified intermediary has to go into the purchase. Not most of it. All of it.
Here's what that looks like with real numbers.
You sell a property for $1,000,000. Selling costs run $60,000, so your net sale price is $940,000. You pay off a $400,000mortgage, and $540,000 goes to your qualified intermediary.
To defer the full tax you need to buy something worth at least $940,000, put the entire $540,000 into it, and cover the remaining $400,000 with new debt or your own cash.
Buy a $940,000 building with a $400,000 loan and your $540,000 down payment, and you're clean.
Buy an $800,000 building instead, and you're $140,000 short on value. That shortfall is taxable.
What "boot" actually is
Boot is just the industry word for the part that didn't make it into the exchange. It comes in two flavors and they behave differently.
Cash boot is money you didn't reinvest. You take $50,000 off the table at closing, that $50,000 is taxable.
Mortgage boot is debt relief. You paid off a $400,000 loan and only took on a $250,000 loan, so you're $150,000 lighter on debt. The IRS treats that reduction as a benefit you received, and it's taxable.
The asymmetry that catches people: you can offset mortgage boot by bringing additional cash to the purchase. Put $150,000 of your own money in and the debt shortfall goes away. But it doesn't work the other way — you can't offset cash boot by taking on a bigger loan. Pocketing proceeds is taxable regardless of how you finance the replacement.
So what happens to my mortgage?
This is one of the most-asked questions about exchanges, and it doesn't have an answer on its own. It only makes sense inside the math above.
Your existing loan gets paid off at closing, like any sale. What matters is what you do about that debt on the replacement side. Replace it with a comparable loan, or replace it with cash, or recognize the difference as boot and pay tax on it. Those are the three options.
Which means your financing isn't a detail you sort out after you pick a property. It's part of whether the exchange works at all.
"The 45-day deadline isn't the real problem. The real problem is entering Day 1 without knowing what you're trying to accomplish with the equity."
A partial exchange isn't a failed exchange
Worth saying plainly, because investors sometimes talk themselves into a bad property to avoid any boot at all.
If you come up short, you don't lose the whole deferral. You pay tax on the boot and defer the rest. Taking $80,000 off the table means paying tax on $80,000, not on your entire gain.
Sometimes that's the right call. If the only way to hit your number is buying something you don't want to own for the next decade, paying tax on a slice of it is the cheaper mistake.
"The most expensive mistake in a 1031 exchange isn't necessarily paying taxes. Sometimes it's avoiding the tax bill so aggressively that you end up owning the wrong property."
What boot actually costs you
If you do end up with boot, the tax isn't one flat rate. It's usually a stack.
Federal long-term capital gains, at your bracket. Depreciation recapture at 25% on the depreciation you've claimed over the years, which surprises long-term owners more than anything else. And potentially the 3.8% net investment income tax.
One piece of good news if you're selling in Texas: there's no state income tax, so you avoid a layer that investors in California or New York can't. It's a real advantage and worth factoring in when you're weighing whether a partial exchange is tolerable.
Your CPA should run these numbers before you commit to a replacement property, not after. The difference between a full and partial exchange can be large enough to change which building you buy.
The part that's harder right now
Here's what the national explainers don't account for.
Debt replacement assumes you can get the loan. On paper it's simple — replace $400,000 of debt with $400,000 of new debt. In practice, lenders have gotten more conservative about investment property, they want more documentation, and they take longer to deliver it.
That creates a specific trap. You can be fully committed on price, fully identified, well inside your 45 days, and still end up short on debt replacement because the loan came back smaller than you underwrote. At that point your options are bringing cash you hadn't planned to bring, or accepting mortgage boot you hadn't planned to pay.
The fix is boring and it works: get your lender engaged before you sell, not after you identify. Know what you can actually borrow before your number depends on it.
Frequently asked questions
Do I have to reinvest 100% of the sale price? You have to buy property worth at least your net sale price and reinvest all your net proceeds. The rest can come from new debt or your own cash.
What happens if I buy something cheaper than what I sold? The difference is boot and it's taxable. You keep the deferral on the rest.
Can I take some cash out of a 1031 exchange? Yes, but it's taxable. There's no way to pull proceeds tax-free — that's the whole mechanism.
What if I don't want a mortgage on the new property? Then you need to bring cash equal to the debt you paid off. Cash offsets mortgage boot. Not replacing that debt at all makes the shortfall taxable.
Do selling costs count against what I need to reinvest? Ordinary transaction expenses like commissions, title fees, and QI fees generally reduce the amount you have to reinvest. Ask your CPA which of your specific costs qualify.
Does the replacement property have to have the same loan-to-value? No. Only the dollar amount of debt matters, and cash can replace debt. A property with a smaller loan works fine if you put more equity in.
Can I use exchange funds for improvements to the new property? Only through a specifically structured improvement exchange, set up before closing. You can't buy a property and then use leftover exchange funds to renovate it.
Is it better to take boot or buy the wrong property? That depends on your numbers and your goals, and it's a real question rather than a rhetorical one. Run the tax cost with your CPA and compare it honestly against ten years of owning something you didn't want.
Part of our guide to commercial real estate and 1031 exchanges in San Antonio.
Related: What can you actually buy with a 1031 exchange in San Antonio?
Schedule a 1031 strategy call with JJ: https://calendly.com/treygroupcommercial/15min
JJ Gorena helps investors across San Antonio, Boerne, New Braunfels, and the Texas Hill Country structure 1031 exchanges the right way.
Nothing in this article is tax or legal advice. Every exchange is different, so talk with your CPA and a qualified intermediary before you make a move.
JJ Gorena II Trey Group Commercial | eXp Realty TREC License #0522975 (210) 367-6024commercial@thetreygroup.com
