Updated August 17, 2026
The rule sellers miss is not about money they receive. It is about debt they no longer owe. If your relinquished building carried a mortgage that got paid off at closing and your replacement carries less debt, the reduction is mortgage boot and it is taxable — even though you never touched a dollar. On a leveraged LA building trading into something smaller or less leveraged, this is the single most common way a "full" exchange turns out to be partial.
To defer the entire gain you generally need to satisfy both:
Equal or greater value. The replacement property's price at least equals the relinquished property's sale price.
Equal or greater debt — or cash to make up the difference. Either take on at least as much debt as you paid off, or contribute additional cash of your own.
That second half is where sellers are caught. Selling a $6 million building with a $3 million loan and buying a $6 million replacement with a $2 million loan leaves $1 million of mortgage boot, despite reinvesting every dollar of equity.
The offset works in one direction only: cash can cover a debt shortfall; new debt cannot offset cash you took out.
Two patterns make it common here.
Long-held, heavily leveraged buildings. Owners who refinanced during the low-rate years carry substantial debt against a low basis. Replacing that debt at current rates on a replacement property is a bigger ask than it was.
The deliberate move to lower leverage. Sellers exiting management-heavy rent-stabilized buildings frequently want less debt in the next phase — a net-leased asset owned outright, or a smaller loan. That is a sensible life decision and it creates mortgage boot every time.
Neither is wrong. Both need to be modeled before the replacement is identified rather than discovered at filing.
You have 180 days from the relinquished closing to acquire the replacement, and the lender's process sits inside that.
Get pre-positioned before you list. A lender relationship, a rough sizing, and a clear picture of what you can borrow — established while your building is still being marketed.
Expect the lender to size to the replacement's income, not to your intentions. On a below-market rent roll, that can produce a smaller loan than the debt you are trying to replace, which reopens the boot problem.
Assumption changes the arithmetic. If the replacement carries assumable debt, that can solve the debt-replacement requirement neatly — but agency assumptions run 45 to 90 days on the lender's timetable, which has to fit inside your 180.
Parked-property structures are harder to finance. A reverse or improvement exchange involves an accommodation titleholder holding title, and not every lender will fund that. Confirm in writing before closing on the relinquished property.
Bring cash. The simplest fix. Additional cash contributed to the replacement purchase offsets the debt shortfall dollar for dollar.
Buy a more expensive property with more debt. Straightforward, if it is a property you actually want.
Add a second replacement property. The identification rules allow up to three under the Three-Property Rule; a second acquisition can absorb both value and debt.
Use a DST interest for the remainder. Delaware Statutory Trusts often carry their own leverage, which can help satisfy the debt requirement as well as the value requirement. This is one of the main reasons they exist.
Accept the boot deliberately. Sometimes the tax on a modest amount of boot is cheaper than contorting the purchase. Model it — and note that on a low-basis LA building, boot is frequently taxed at the depreciation recapture rate rather than the capital gain rate, which makes it more expensive than sellers assume.
That last item is the one that prevents the surprise. It takes an hour and it is the difference between a full deferral and a partial one.
Do I have to replace the debt exactly?
You need equal or greater total investment. Debt is one way to get there and cash is the other — a shortfall in debt can be covered with additional cash you contribute.
What if I want less debt than before?
Then you either bring cash to make up the difference, buy a larger property, add a second replacement, or accept mortgage boot on the reduction. Wanting lower leverage is legitimate; it just has a price that should be known in advance.
Can I refinance the replacement property after the exchange?
Refinancing afterwards is common, but a refinance arranged as part of the exchange to extract cash can be treated as boot. The timing and the facts matter — raise it with your CPA rather than assuming a gap between closing and refinancing solves it.
Can I pull cash out of the relinquished property before selling?
A refinance shortly before a sale, done to extract proceeds, invites the same treatment. This is an area where sellers get creative and get caught. Ask first.
Will a lender lend on a property held by an accommodation titleholder?
Some will and many will not. On a reverse or improvement exchange this must be confirmed in writing before the relinquished property closes, because there is no fixing it afterwards.
Most failed deferrals are not failures of discipline about the 45 days. They are quiet shortfalls on the debt side, discovered at filing by a seller who reinvested every dollar of equity and assumed that was the whole test. Get a written value-and-debt model from your CPA before you identify anything, and get a lender pre-positioned before you list.
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