How much debt do you need to replace in a 1031 exchange?
The short answer
To fully defer your taxes, you have to replace any mortgage that was paid off when you sold, either by taking on at least the same amount of new debt on the replacement property or by adding the same amount in cash. The simplest way to size the new loan is the replacement price minus the equity you are reinvesting. When you buy at your reinvestment goal, that figure equals your old loan balance.
That single rule is where a surprising number of 1031 exchanges go wrong. A loan broker quotes financing based on the replacement property and the client's credit, not on the exchange math, and the loan ends up larger than the exchange actually needs. The result is that some of the client's equity is handed back at close, and that returned cash is taxable. The calculator above sizes the loan the other way around, starting from what the exchange requires, so the financing fits the deferral instead of breaking it.
The three numbers that decide it
Every debt replacement question comes down to three figures. Get these right and the loan amount falls out automatically.
1. Reinvestment goal (net sales price)
This is the amount your client must reinvest to pay zero tax. It is the sale price minus the allowable closing costs, mainly the realtor or broker commission plus escrow, legal, and the qualified intermediary fee. A reliable rule of thumb when a realtor is involved is to take 95 percent of the sale price and round down. Property taxes, insurance, repairs, and lender fees are not part of this figure.
2. Equity (the cash proceeds)
This is the cash held for your client after the sale: the reinvestment goal minus the mortgage that was paid off. Every dollar of it has to go back into the next property. Any equity the client keeps is taxable.
3. Debt to replace
This is the loan to write. It is the replacement price minus the equity being reinvested, which is the financing needed to cover the rest of the purchase once all the equity is in. When the client buys exactly at the reinvestment goal, this number is identical to the loan that was just paid off.
A worked example
Take a client selling a property for one million dollars with a five hundred thousand dollar mortgage. Here is how the three numbers line up, matching the calculator's default values.
| Sale price | $1,000,000 |
| Allowable closing costs | $55,005 |
| Reinvestment goal (net sales price) | $944,995 |
| Mortgage paid off | $500,000 |
| Equity (cash proceeds) | $444,995 |
| Debt to replace | $500,000 |
To buy a replacement property at the $944,995 goal, the client puts in all $444,995 of equity and needs a loan of $500,000. Notice that the debt to replace matches the original mortgage exactly. That is the clean case, and it is the benchmark every loan quote should be checked against.
Two ways to replace the debt
When there is debt on the relinquished property, there are two routes to the reinvestment goal, and they can be combined.
Take on new debt
Finance the replacement property with a new loan of at least the amount that was paid off. In the example, that is a $500,000 mortgage on top of the $444,995 in equity.
Add cash instead
Bring additional out-of-pocket cash to close in place of the loan. In the example, $500,000 of new cash on top of the equity reaches the same goal with no financing at all.
The IRS treats new debt and new cash the same for this purpose, so a smaller loan is fine as long as the client makes up the gap with cash. What the client cannot do is replace neither. A shortfall that is not covered by debt or cash is taxable.
Why an oversized loan creates a taxable event
This is the trap the tool is built to catch. A loan that is larger than the target does not help the client defer more tax. It simply means the client needs less of their own equity for the down payment, so the leftover equity is returned to them at close. That is the moment a clean exchange picks up a tax bill. The leftover cash is taxable boot, and it usually comes as a surprise because everyone assumed a bigger loan was a good thing.
In the example, a $600,000 loan against the $944,995 property drops the down payment to $344,995. The client only needs that much of their $444,995 equity, so $100,000 flows back to them and becomes taxable. There are two forms this leakage can take.
Cash boot
Sale proceeds the client receives instead of reinvesting. Taxable up to the amount of the gain. The usual cause is a loan larger than the exchange needs.
Mortgage boot
Also called debt boot. Created when the new debt is less than the debt paid off and the difference is not covered by new cash. Adding cash equal to the gap cancels it out.
A loan broker's checklist for sizing 1031 financing
Before you finalize a quote for a client who is mid-exchange, run these steps. They take a minute and protect the deferral the client is counting on.
- Get the sale price and the exact mortgage payoff on the property the client is selling.
- Calculate the reinvestment goal: the sale price minus closing costs, or roughly 95 percent of the sale price.
- Calculate the equity: the reinvestment goal minus the payoff. This is the cash that must be reinvested.
- Size the loan as the replacement price minus that equity. That is the target.
- Never write a loan larger than the target without telling the client the excess returns to them as taxable cash.
- If the loan has to be smaller, tell the client exactly how much outside cash to bring to close.
- Point the client to their qualified intermediary and CPA to confirm the final figures.
The two misconceptions that cause most boot
Two assumptions trip up investors and the professionals who advise them. The first is that you only need to reinvest the equity you received at the sale. The second is that you only need to reinvest your capital gain. Both are wrong. The target is the reinvestment goal, the net sales price, which is almost always larger than either the equity or the gain. Sizing a loan to the wrong target is how taxable boot slips into an otherwise clean exchange.
Frequently asked questions
Do you have to replace debt in a 1031 exchange?
Not with new debt specifically, but you do have to replace its value. Any mortgage paid off at the sale has to be covered on the purchase side, either by taking on at least as much new debt or by adding the same amount in cash. If you do neither, the difference is taxable.
How much debt do I need to replace?
The simplest way to size it is the replacement price minus the equity you are reinvesting. When you buy at your reinvestment goal, that figure equals the loan balance you paid off at sale. The calculator above does this for you.
Can I replace debt with cash instead of a new loan?
Yes. The IRS treats new debt and new cash the same for this purpose. You can take a smaller loan, or none at all, as long as you make up the difference with additional out-of-pocket cash and still buy at or above your reinvestment goal.
What happens if my new loan is bigger than my old loan?
A larger loan is fine for tax deferral by itself, but it changes the cash math. If the loan covers more of the purchase price, you need less of your own equity for the down payment, and the leftover equity is paid back to you at close. That returned cash is taxable. This is the most common way a loan broker accidentally creates a tax bill.
What is cash boot?
Cash boot is any sale proceeds you receive instead of reinvesting. It is taxable up to the amount of your gain. The classic cause is a replacement loan that is larger than needed, which hands unused equity back to you.
What is mortgage boot or debt boot?
Mortgage boot, also called debt boot, is the taxable amount created when the debt on your replacement property is less than the debt you paid off and you do not make up the difference with new cash. Adding cash equal to the debt reduction cancels it out.
Does the new loan have to be the exact same amount as the old one?
No. It has to be enough, combined with the cash you reinvest, to buy at or above your reinvestment goal without returning any equity to you. A more expensive replacement property needs a larger loan, while adding extra cash lets the loan be smaller.
Is the debt to replace the same as my down payment?
No. Your down payment is the equity you put in. The debt to replace is the loan that funds the rest of the purchase. Down payment plus loan equals the replacement price.