Karen sold a rental for $750,000 with a $300,000 mortgage and assumed she was trading at the same price by buying a $700,000 property with a $250,000 mortgage. She reinvested all her equity but shed $50,000 of debt without replacing it, and that debt relief became about $50,000 of taxable boot. A clean 1031 exchange has to match the old property on both value and debt, not price alone.
This case study is illustrative. Names, figures, and details are composite examples based on common investor scenarios. Consult a qualified tax professional for advice specific to your situation.
Karen did everything a 1031 exchange asks for. She sold her Atlanta rental for $750,000, rolled the proceeds into a $700,000 townhouse complex, held the cash with a neutral middleman, and beat every deadline. A year later her accountant found a $14,800 tax bill she never saw coming. It came down to one number she hadn't thought to check.
The sale
Karen owned a rental house in the suburbs outside Atlanta, bought 20 years ago for $300,000. She had paid the mortgage down from $240,000 to $100,000, then refinanced about five years ago and pulled cash out, taking the balance back up to $300,000.
The house had climbed in value. A 2026 appraisal put it at $750,000. Against the $300,000 mortgage, that left her with $450,000 of equity.
She had built a small real estate portfolio over the years and wanted to spread it across more markets. The plan was to sell in Atlanta and buy in a more up-and-coming area, maybe a townhouse complex or a small multi-unit building.
She sold for $750,000. Her agent's commission ran 6%, or $45,000, and title, inspection, and the rest of the closing costs added $8,000, leaving about $697,000. The $300,000 mortgage was paid off out of the proceeds.
Her capital gain came to roughly $450,000: the $750,000 sale price minus the $300,000 she originally paid, her cost basis. Sell outright and she would owe about $135,000 in federal, state, and net investment income tax (NIIT).
This uses her original purchase price as the cost basis, which keeps the math simple. After 20 years of rental depreciation, the yearly deductions that lower a property's basis, her adjusted basis would be lower and her real gain higher. Recaptured depreciation is taxed at up to 25%, so her true bill would likely be larger than the figure here.
To defer that tax, she chose a 1031 exchange, which lets a real estate investor roll the gain from one property into another, as long as the swap follows a strict set of rules.
Identifying the replacement
Karen's broker found a three-unit townhouse complex two hours away, listed at $700,000. It threw off solid rent, sat in a neighborhood with room to appreciate, and Karen liked it. She named it as her replacement property inside the 45-day window the rules allow, and closed by day 150, comfortably within the 180 days a 1031 gives you.
She financed it with a $250,000 mortgage and put down $450,000 from her sale proceeds, which flowed through her qualified intermediary, or QI - the neutral party who holds the cash between the sale and the purchase so the investor never takes possession of it.
On paper it looked clean. She sold, she bought, she used a QI, she beat every deadline. The QI prepared the exchange paperwork, and Karen figured she was done.
A year later, filling out her return, her CPA asked one question: how did the loan on the new property compare with the loan she paid off on the old one?
The old house carried a $300,000 mortgage; the new one carried $250,000. That $50,000 gap, the CPA explained, was debt relief, and combined with buying a property $50,000 cheaper than the one she sold, it left her with about $50,000 of boot. Boot is the part of an exchange you don't roll forward - cash or debt relief you effectively keep - and it is taxable.
"What does that mean?" Karen asked.
"It means you owe tax on $50,000 of your gain."
The mistake: one gap, seen two ways
Karen's error was simple. She compared the purchase price with the sale price and stopped there. She never looked at the debt.
Here is the full picture. On the sale, she had a $750,000 property, a $300,000 mortgage, and $450,000 of equity. On the purchase, she had a $700,000 property, a $250,000 mortgage, and the same $450,000 of equity going back in.
She put every dollar of equity back to work. What she failed to replace was debt. She walked in owing $300,000 and walked out owing $250,000, and the $50,000 she no longer owed counts as money received.
The price gap and the debt gap are not two separate holes. They are the same $50,000. Because her equity held steady at $450,000, "bought $50,000 cheaper" and "borrowed $50,000 less" are two ways of describing one shortfall. She could have closed it by adding $50,000 of cash or taking on $50,000 more debt. She did neither.
Her CPA flagged the cash side as messy too. On paper, the roughly $697,000 in net proceeds against a $450,000 down payment leaves about $247,000 unaccounted for; some went to closing costs on the new property, but because Karen had not run everything carefully through her QI, the trail was hard to reconcile.
A capable QI should have caught the boot before closing. Karen's did not. That her CPA was the one to find it, a year later at tax time, told her the QI had not done the work.
The tax bill
Karen's gain was about $450,000, taxed at roughly 29.6%: 20% federal, 5.8% state, and 3.8% NIIT. On $50,000 of boot, that is about $14,800.
She had to amend the prior year's return, pay the $14,800, and pay interest on the back taxes on top. The whole point of the exchange had been to skip the tax. She still deferred it on $400,000 of the gain, but the surprise on the last $50,000 stung.
How the boot could have been avoided
The rule behind a fully deferred exchange is not complicated: the replacement has to match or beat the old property on two counts, value and debt.
For Karen, that meant two checks before she made an offer. Was the purchase price at least the $750,000 she sold for? At $700,000, no, a $50,000 shortfall. Was the new mortgage at least the $300,000 she paid off? At $250,000, no, another $50,000 shortfall. Miss either and the gap becomes boot.
She had a few ways to close it. Buying at $750,000 or more would have erased the price shortfall. Financing $300,000 or more would have erased the debt shortfall. Doing both, buying at $750,000 or higher with at least $300,000 of debt, would have left no boot at all. Adding fresh cash to cover the gap works too.
What the case teaches
Debt counts, not just price. New exchangers tend to fixate on the purchase price and forget that shedding debt is also boot. Both have to be matched.
A QI who knows the price and the financing before the offer can model the boot in advance. One who sees the deal only after closing cannot. That is the difference between a QI who catches a $14,800 problem and one who doesn't.
Boot isn't always an accident. Some investors deliberately take some cash out of a sale and plan to pay the tax on it. The trouble is triggering it without meaning to.
What Karen did next
Karen asked her QI whether anything could be undone. Nothing could. She had already closed, and the exchange was final. She paid the bill and kept the lesson. She also fired the QI and hired one who agreed to review the price and financing on future deals before she committed. She still plans to keep using exchanges; even with the mistake, deferring tax on $400,000 was worth it to her.
The bottom line
Karen treated a 1031 exchange as a price comparison when it is really a comparison of economic value, price and debt together. Reduce either against the sale, and the difference is boot.
A gain and tax calculator can lay out the numbers on a planned exchange, and an advisor can review a replacement property before you commit. For more on the mechanics, see our explainers on 1031 exchange boot and closing costs in a 1031 exchange.
Boot shows up when you pull cash out of a sale or shed debt without replacing it. A fully deferred exchange has to match the old property on both value and debt; if the replacement is lower on either, the gap is taxable.
Frequently asked questions
What is boot in a 1031 exchange?
Boot is any cash or debt relief you take out of an exchange instead of rolling it into the replacement property. If the replacement costs less than what you sold, or carries less debt than you paid off, the difference is boot, and it is taxable.
Why did Karen's exchange have boot?
She bought cheaper and borrowed less: $700,000 versus the $750,000 she sold, with a $250,000 mortgage versus the $300,000 she paid off. Because her equity stayed the same, that is one $50,000 gap seen two ways, and the debt she shed without replacing counted as roughly $50,000 of boot.
How is boot taxed?
Boot is taxed as gain, at your capital gains rate, up to the size of your total gain. With a $200,000 gain and $50,000 of boot, you would owe tax on the $50,000.
Could Karen have avoided this?
Yes. Buying at $750,000 or more, or financing $300,000 or more, would have closed the gap. The replacement needs to match or beat the old property on both price and debt.
What's the formula for checking boot?
Subtract the new purchase price from the sale price, and the new debt from the old debt; any positive result on either is boot. To defer the full gain, both the new price and the new debt need to be at least as high as the old ones.