22.2 Boot Recognition & Basis Calculation for Replacement Property

EA Part 2 — Businesses: Free Study Guide 2026 Exam

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1 Chapter 1: Exam Cycle & Preparation

1.1 Current Exam Cycle, Blueprint & Study Decisions

2 Chapter 2: Business Entity Choices & Classification

2.1 Business Structures & Liability: Sole Proprietorship, Partnership, LLC, and Corporation 2.2 Entity Classification & Check-the-Box Rules (Form 8832) 2.3 Classification Elections, Default Rules & the 60-Month Limitation 2.4 EINs, Entity Changes & Closing a Business

3 Chapter 3: Sole Proprietorships

3.1 Schedule C Gross Income & Allowable Business Expenses 3.2 Self-Employment Tax (Schedule SE) & Statutory Employees 3.3 Business Use of Home (Simplified vs. Actual Method)

4 Chapter 4: Partnership Formation & Basis

4.1 Formation & Property Contributions under Section 721 4.2 Partner Liabilities under Section 752 (Recourse vs. Nonrecourse) 4.3 Partnership Tax Year, Accounting Periods & Form 1065 Filing 4.4 Family Partnerships, Gifted Interests & Income Allocations

5 Chapter 5: Partnership Basis & Loss Limitations

5.1 Outside Basis Calculations & Ordering Rules 5.2 Basis, At-Risk (§465) & Passive Loss (§469) Limitations 5.3 Excess Business Losses (§461(l)) & Related-Party Transactions (§707) 5.4 Debt Discharge: Partnership vs. S Corporation

6 Chapter 6: Partnership Operations & Distributions

6.1 Form 1065, Schedule K & Schedule K-1 Separately Stated Items 6.2 Guaranteed Payments vs. Distributive Shares 6.3 Nonliquidating & Liquidating Distributions & Section 751 Hot Assets 6.4 Centralized Partnership Audits, Notices & Opting Out

7 Chapter 7: Partnership Dispositions & Basis Adjustments

7.1 Sale or Exchange of a Partnership Interest 7.2 Optional Basis Adjustments (Section 754, 743(b) & 734(b)) 7.3 Partnership Terminations, Mergers & Divisions

8 Chapter 8: C Corporation Formation & Structure

8.1 Corporate Formation & Section 351 Transfer Requirements 8.2 Boot, Section 357 Liabilities in Excess of Basis & Section 1244 Stock 8.3 Capital Structure: Debt vs. Equity & Section 385 Principles 8.4 Controlled Groups & Closely Held Corporations

9 Chapter 9: C Corporation Operations & E&P

9.1 Form 1120 Gross Income, Corporate Deductions & 21% Flat Tax Rate 9.2 Book-Tax Differences (Schedule M-1 vs. Schedule M-3) 9.3 Current vs. Accumulated Earnings & Profits (E&P) 9.4 Accumulated Earnings & Personal Holding Company Taxes 9.5 Corporate Minimum Tax & Foreign Tax Credits

10 Chapter 10: C Corporation Distributions & Liquidations

10.1 Property Distributions, Dividends & Constructive Distributions 10.2 Stock Redemptions (§302) & Corporate Liquidations (§331/§336)

11 Chapter 11: S Corporation Eligibility & Operations

11.1 S Corporation Requirements & Form 2553 Election Rules 11.2 Election Deadlines, Late Election Relief (Rev. Proc. 2013-30) 11.3 Form 1120-S Operations, Reasonable Compensation & 2% Shareholder Fringes

12 Chapter 12: S Corporation Basis, Distributions & Taxes

12.1 Stock & Debt Basis Calculations, Ordering Rules & Form 7203 12.2 S Corp Distributions, Accumulated Adjustments Account (AAA) & E&P Tiers 12.3 Entity-Level Taxes (BIG §1374 & Passive Income §1375) & Termination

13 Chapter 13: Accounting Periods & Methods

13.1 Tax Years: Calendar, Fiscal, and 52-53 Week Years 13.2 Cash vs. Accrual Method & Section 448 Gross Receipts Test 13.3 Changes in Accounting Method (Form 3115) & Section 481(a) Adjustments 13.4 2025 Domestic Research Expensing & Foreign Research

14 Chapter 14: Business Gross Income & Inventory

14.1 Gross Receipts & Inclusions in Business Gross Income 14.2 Cost of Goods Sold (COGS) & Inventory Valuation (Cost, LCM, FIFO, LIFO) 14.3 Section 263A Uniform Capitalization (UNICAP) & Small Business Exemption

15 Chapter 15: General Business Deductions & Limits

15.1 Ordinary & Necessary Business Expenses (§162) & Disallowances 15.2 Business Meals, Gifts & Travel 15.3 Vehicle Expenses, Mileage & Substantiation 15.4 Business Interest Expense Limitation (§163(j)) & Business Taxes

16 Chapter 16: Business Losses & Net Operating Losses

16.1 Net Operating Losses (NOLs) 80% Taxable Income Cap & Carryforward Rules 16.2 Business Casualty, Theft & Disaster Losses 16.3 Business vs. Nonbusiness Bad Debts (Direct Write-Off Method §166)

17 Chapter 17: Section 199A Qualified Business Income Deduction

17.1 Section 199A Overview: 20% Deduction & Qualified Trades or Businesses 17.2 Specified Service Trades or Businesses (SSTBs) & Threshold Phase-Outs 17.3 W-2 Wage & UBIA Limitations Calculation & Aggregation Rules

18 Chapter 18: Depreciation Principles & MACRS

18.1 Depreciable Property, Cost Basis & Capitalization vs. Repair Regulations 18.2 MACRS Property Classes (3, 5, 7, 15, 27.5, 39-Year) & Depreciation Methods 18.3 Depreciation Conventions: Half-Year, Mid-Quarter (40% Rule) & Mid-Month

19 Chapter 19: Section 179 Expensing & Bonus Depreciation

19.1 Section 179 Expensing: $2.5M Limit, $4M Phase-Out & Taxable Income Limitation 19.2 2025 Bifurcated Bonus Depreciation: Pre-Jan 20 (40%) vs. Post-Jan 19 (100% OBBBA) 19.3 Listed Property Rules, >50% Business Use & Section 280F Luxury Auto Limits

20 Chapter 20: Amortization & Intangible Assets

20.1 Section 197 Intangibles & 15-Year Straight-Line Amortization 20.2 Start-Up (§195) & Organizational (§248/§709) Expenditures: $5,000 Rule & 180-Month Amortization 20.3 Depletion: Cost Depletion vs. Percentage Depletion for Natural Resources

21 Chapter 21: Business Property Dispositions & Recapture

21.1 Sale of Business Property & Reporting on Form 4797 21.2 Section 1231 Netting Process & 5-Year Lookback Recapture Rule 21.3 Section 1245 (Full Personal Property Recapture) & Section 1250 / Unrecaptured §1250 Gain

22 Chapter 22: Like-Kind Exchanges & Involuntary Conversions

22.1 Section 1031 Like-Kind Exchanges (Real Property Only, 45-Day/180-Day Deadlines) 22.2 Boot Recognition & Basis Calculation for Replacement Property 22.3 Section 1033 Involuntary Conversions & Replacement Periods

23 Chapter 23: Business Tax Credits

23.1 General Business Credit (Form 3800), Net Income Tax Limit & Carryback/Carryforward 23.2 Key Business Tax Credits: Research Credit (§41), WOTC (§51), Small Employer Health (§45R)

24 Chapter 24: Worker Classification & Information Reporting

24.1 Employee vs. Independent Contractor: Common Law Control & Form SS-8 24.2 Section 530 Relief Requirements & Consequences of Misclassification 24.3 Information Returns: Form 1099-NEC vs. 1099-MISC, Form W-2/W-3 & Backup Withholding

25 Chapter 25: Employment Taxes & Compliance

25.1 Form 941 (Quarterly Payroll Tax Return) & Federal Income Tax / FICA Withholding 25.2 Federal Unemployment Tax (Form 940) & State Unemployment Credit 25.3 Payroll Tax Deposit Schedules (Monthly vs. Semi-Weekly, $100K Rule) & Trust Fund Penalty (§6672)

26 Chapter 26: Fiduciary Income Taxation (Trusts & Estates)

26.1 Principles of Fiduciary Income Taxation & Form 1041 Filing Requirements 26.2 Fiduciary Tax Years, Exemptions & Estimated Payments 26.3 Simple and Complex Trusts, Tiers & Distribution Timing 26.4 DNI Computation & Fiduciary Expense Allocation 26.5 Income Distribution Deduction & Schedule K-1 (Form 1041) Flow-Through 26.6 Foreign Trusts, Grantor Control & Abusive Schemes

27 Chapter 27: Tax-Exempt Organizations & Farm Taxation

27.1 Recognition of Tax Exemption (Form 1023/1024) & §501(c)(3) Standards 27.2 Maintaining Exemption, Political Activity & Excess Benefits 27.3 Form 990 Series Annual Returns & Unrelated Business Taxable Income (UBTI / Form 990-T) 27.4 Unrelated Business Income & Debt-Financed Property 27.5 Farm Income, Schedule F & Conservation Costs 27.6 Farm Income Averaging & Conservation Deductions 27.7 Farm Disaster Elections & Livestock Replacement 27.8 Farm Rentals, Estimated Tax & Farm Depreciation

28 Chapter 28: Business Records, Reporting & ACA

28.1 Financial Statements, Records & Owner Transactions 28.2 Filing Extensions, International Forms & Cash Reporting 28.3 ACA Employer Size, Coverage & Reporting

29 Chapter 29: Employer & Self-Employed Retirement Plans

29.1 Qualified Plans, 401(k) Limits & Nondiscrimination 29.2 SEPs, Self-Employed Contributions & Owner Compensation 29.3 SIMPLE IRAs & Small-Employer Contribution Choices 29.4 Plan Reporting, Loans & Prohibited Transactions

30 Chapter 30: Rental Property & Passive Activities

30.1 Rental Income, Expenses & Conversion Basis 30.2 Rental Losses, Active Participation & Real Estate Professionals 30.3 Vacation Homes, Personal Days & Rental Allocations

22.2 Boot Recognition & Basis Calculation for Replacement Property

Key Takeaways Explain This Topic AI

Boot is any non-like-kind property or money received in an exchange, including cash, net mortgage relief (liabilities relieved exceeding liabilities assumed), and personal property.

Under IRC §1031(b), realized gain is recognized up to the fair market value of boot received (Recognized Gain = Lesser of Realized Gain OR Boot Received); realized losses are NEVER recognized under IRC §1031(c), even if boot is given or received.

Under Treasury mortgage netting rules, liabilities assumed offset liabilities relieved, and cash paid offsets net liability relief; however, liabilities assumed CANNOT offset cash received (cash boot received is always taxable up to realized gain).

The tax basis of replacement property under IRC §1031(d) equals: Adjusted Basis of Relinquished Property + Cash/Boot Paid + Gain Recognized - Cash/Boot Received - Net Mortgage Relief. It can be verified as: FMV of Replacement Property minus Deferred Gain (or plus Deferred Loss).

Under IRC §1031(f), if an exchange occurs between related parties, both parties must hold their respective exchange properties for at least 2 years; a disposition by either party within 2 years revokes tax deferral retroactively, triggering gain recognition in the year of disposition.

Last updated: October 2026

The Concept and Nature of "Boot"

In a perfect Section 1031 exchange, two properties of equal value and identical equity are swapped without the transfer of cash or debt. In commercial practice, however, real estate parcels rarely have identical market valuations or matching debt encumbrances. To equalize the transaction, one party must provide additional consideration.

In tax terminology, boot refers to any non-like-kind property or money transferred to balance an exchange. Boot includes:

Cash / Money : Currency, wire transfers, escrow cash balances, and promissory notes received by the taxpayer.

Non-Like-Kind Property : Personal property included in the real estate transaction (such as appliances, furniture, tractors, or maintenance equipment), corporate stock, or partnership interests.

Net Liability Relief (Mortgage Boot) : The net reduction in the taxpayer's liabilities resulting from the transfer of debt encumbering the relinquished property in excess of debt assumed on the replacement property.

The Rules of Gain and Loss Recognition

When a taxpayer receives boot in a like-kind exchange, the transaction becomes partially taxable under IRC §1031(b) . Step-by-Step Recognition Framework:

Step 1: Compute Amount Realized
Amount Realized = FMV of Replacement Property + Cash Received + FMV of Non-Cash Boot
+ Relinquished Debt Assumed by Buyer - Qualified Selling Expenses

Step 2: Compute Realized Gain (Loss)
Realized Gain (Loss) = Amount Realized - Adjusted Basis of Relinquished Property

Step 3: Determine Recognized Gain
Recognized Gain = Lesser of: (1) Realized Gain, OR (2) Fair Market Value of Boot Received

Step 4: Determine Recognized Loss
Recognized Loss = \$0 (NEVER recognized under IRC §1031(c))
Absolute Disallowance of Losses (IRC §1031(c))

Under IRC §1031(c) , no loss is recognized from an exchange of like-kind property, even if the taxpayer receives or gives cash or boot! If a taxpayer transfers a commercial building with an adjusted basis of $800,000 in exchange for like-kind real estate worth $600,000 plus $50,000 cash, the taxpayer has a realized loss of $150,000 ($650,000 amount realized - $800,000 basis). The $50,000 cash boot received does not trigger gain recognition because there is no realized gain, and the $150,000 loss is completely nondeductible. The unrecognized loss is preserved by increasing the tax basis of the replacement property to $750,000 ($800,000 basis - $50,000 cash received).

Note

Exception for Non-Like-Kind Property Given as Boot :

If a taxpayer transfers appreciated or depreciated non-like-kind property (e.g., corporate stock or personal equipment) as boot in order to acquire like-kind real estate, the taxpayer must recognize gain or loss on the transfer of that boot property. That transfer is treated as a separate taxable sale of the boot asset at fair market value.

Mortgage Boot & Treasury Netting Rules

When debt-encumbered real estate is exchanged, the debt dynamics are governed by Treas. Reg. §1.1031(b)-1(c) and Treas. Reg. §1.1031(d)-2 . Mortgage Netting Rules Overview:

Liability Relieved (Old Debt): Treated as money received by taxpayer (Boot Received)
Liability Assumed (New Debt): Treated as money paid by taxpayer (Boot Given)
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Net Liability Relief: Old Debt - New Debt (if positive, tentative boot received)
Permissible Offsets vs. The Strict Asymmetry Trap

The IRS enforces strict structural rules regarding what can and cannot be netted:

Debt Relief vs. Debt Assumed : Liabilities relieved are directly offset by liabilities assumed on the replacement property. If the taxpayer transfers property encumbered by a $400,000 mortgage and acquires replacement property encumbered by a $550,000 mortgage, net debt relief is $0 (the taxpayer has net debt assumed of $150,000).

Cash Paid Offsets Net Debt Relief : If liabilities relieved exceed liabilities assumed, the taxpayer can pay cash (or transfer non-cash boot) to eliminate the net mortgage relief. If old debt is $500,000 and new debt is $300,000 ($200,000 net debt relief), paying $200,000 cash into escrow reduces net mortgage boot to $0.

THE CRITICAL EXAM TRAP: Debt Assumed CANNOT Offset Cash Received! If a taxpayer receives cash out of the exchange, they cannot offset or shelter that cash boot by taking on a larger mortgage on the replacement property! Cash received is taxable boot up to realized gain regardless of how much debt the taxpayer assumes. Permissible and Impermissible Netting Combinations:

[PERMISSIBLE] Liabilities Assumed OFFSETS Liabilities Relieved
[PERMISSIBLE] Cash Paid OFFSETS Liabilities Relieved

[IMPERMISSIBLE] Liabilities Assumed OFFSETS Cash Received <-- CANNOT OFFSET!

Selling Expenses Offset Boot : Qualified transaction expenses (broker commissions, transfer taxes, exchange legal fees, title insurance paid by the taxpayer) reduce the amount realized and may directly offset boot received (both cash boot and mortgage boot) under Rev. Rul. 72-456.

Basis Calculation for Replacement Property (IRC §1031(d))

The foundational objective of Section 1031 is tax deferral , not permanent tax forgiveness. The realized gain that escapes current taxation is preserved for future recognition through a mandatory substituted basis mechanism under IRC §1031(d) .

The Statutory Basis Formula Adjusted Basis of Relinquished Property
+ Cash and non-like-kind boot paid (including adjusted basis of non-cash boot given)
+ Liabilities assumed (debt on replacement property)
+ Gain recognized by the taxpayer
Cash and non-like-kind boot received (FMV)
Liabilities relieved (debt on relinquished property)
Loss recognized on boot property given
====================================================================================
= Adjusted Basis of Replacement Real Property
The Quick Verification Formula on the EA Exam

On the Special Enrollment Examination, candidate speed and accuracy are critical. You can verify your basis calculation in seconds using the Deferred Gain/Loss Verification Formula : Replacement Property Basis = FMV of Replacement Property - Deferred Gain

(or + Deferred Loss)

If your calculated basis does not equal the replacement property's fair market value minus the unrecognized gain, your calculation contains an arithmetic error.

Holding Period Tacking (IRC §1223(1))

Under IRC §1223(1) , when a taxpayer acquires replacement real property in a Section 1031 exchange, the holding period of the relinquished property tacks onto (is added to) the holding period of the replacement property, provided that the relinquished property was held as a capital asset or a Section 1231 asset on the date of the exchange.

Example : A landlord held an apartment complex for 8 years and exchanged it for a commercial warehouse under §1031. Two months after acquiring the warehouse, the landlord sells it. Because the 8-year holding period tacks, the gain is long-term Section 1231 gain rather than short-term capital gain.

Related-Party Exchanges Under IRC §1031(f)

To prevent related taxpayers from engaging in "basis-shifting" schemes (e.g., exchanging high-basis property for low-basis property right before selling the low-basis asset to an unrelated buyer to avoid tax), Congress enacted IRC §1031(f) . Related-Party Exchange Rules (§1031(f)):

Parties Defined (§267(b) / §707(b)(1)): Family members (spouse, siblings, ancestors, descendants),

entities > 50% owned by the taxpayer.

Holding Period Requirement: BOTH parties must hold their exchange properties for

at least TWO (2) YEARS from the date of the last transfer.

Triggering Event: If EITHER party disposes of the property within 2 years,

nonrecognition is REVOKED retroactively.

Tax Consequence: The deferred gain from the original exchange must be recognized

in the tax year of the subsequent disposition!

Statutory Exceptions to the 2-Year Rule (§1031(f)(2))

Gain recognition is not triggered upon a premature disposition within 2 years if:

The disposition occurs after the death of either the taxpayer or the related person;

The disposition results from a compulsory or involuntary conversion under IRC §1033 (provided the exchange occurred before the threat of condemnation arose); or

It is established to the satisfaction of the IRS that neither the exchange nor the disposition had as one of its principal purposes the avoidance of federal income tax .

Comprehensive Worked Numerical Example: Dual Debt Netting, Cash Boot & Basis

Taxpayer Victoria exchanges an existing commercial rental building (Relinquished Property) for a suburban medical office building (Replacement Property). The transaction closes through a Qualified Intermediary with the following financial parameters: Transaction Parameters:

Relinquished Property:

Fair Market Value (FMV): \$1,200,000
Adjusted Tax Basis: \$500,000
Mortgage Transferred (Relieved): \$400,000

Replacement Property:

Fair Market Value (FMV): \$1,500,000
Mortgage Assumed (New Debt): \$650,000

Cash Equalization:

Equity in Relinquished: \$1,200,000 FMV - \$400,000 Debt = \$800,000
Equity in Replacement: \$1,500,000 FMV - \$650,000 Debt = \$850,000
Cash Paid by Victoria into escrow to equalize equity: \$50,000
Selling Expenses: \$0

Step 1: Compute Amount Realized
FMV of Replacement Property: \$1,500,000
Add: Debt Relieved on Relinquished Property: \$400,000
Total Consideration Received: \$1,900,000
Less: Cash Paid by Victoria: (\$50,000)
Amount Realized: \$1,850,000

Step 2: Compute Realized Gain
Amount Realized: \$1,850,000
Less: Adjusted Basis of Relinquished Property: (\$500,000)
Total Realized Gain: \$1,350,000

Step 3: Analyze Boot Received
Cash Boot Received: \$0

- Liability Relief Analysis:

Mortgage Relieved: \$400,000
Less: Mortgage Assumed: (\$650,000)
Net Mortgage Relief: \$0 (Victoria assumed \$250K excess debt)
Total Boot Received by Victoria: \$0

Step 4: Determine Recognized Gain

Recognized Gain = Lesser of Realized Gain (\$1,350,000) or Boot Received (\$0) = \$0.

Deferred Gain = Realized Gain (\$1,350,000) - Recognized Gain (\$0) = \$1,350,000.

Step 5: Compute Adjusted Basis of Replacement Property under IRC §1031(d)
Adjusted Basis of Relinquished Property: \$500,000
Add: Cash Paid: \$50,000
Add: Mortgage Assumed: \$650,000
Add: Gain Recognized: \$0
Less: Mortgage Relieved: (\$400,000)
Less: Boot Received: (\$0)
Adjusted Basis of Replacement Medical Building: \$800,000

Step 6: Verify via Quick Formula
FMV of Replacement Property: \$1,500,000
Less: Deferred Gain: (\$1,350,000)
Verified Replacement Basis: \$800,000 (Matches perfectly!)