Leo Discovers What Boot Actually Costs on His $7M Sale

Leo and his wife live in Washington state—no state income tax—and they’ve owned their building for more than 30 years. It’s time to sell. The property is going for $7 million.

They don’t need all of the cash. This property is part of their legacy, something they want to pass on to their children. The goal is to grow it as efficiently as possible.

Leo has been studying his options carefully. His plan: exchange $2 million into DSTs through a 1031 exchange and pay the tax on the remaining $5 million. His thinking is that he could invest the after-tax proceeds at a higher rate of return—enough to make up for the tax bill.

It’s a reasonable theory. But does the math actually work?

Exchange Planning Corporation ran the numbers using our exchange planning calculators at 1031TaxHub.com to help Leo see exactly what each path would cost him. Leo’s story is a good illustration of what these tools can do to help clients make informed decisions about the sale of their rental properties.

What Happens If Leo Doesn’t Exchange at All

First, Exchange Planning Corporation looked at the scenario where Leo sells outright with no exchange. The estimated federal tax: approximately $1.3 million.

Because most of Leo’s gain would be taxed at the 20% capital gains rate, his overall effective rate comes in around 18.6%. On a $7 million sale, that sounds manageable as a percentage—but $1.3 million is still $1.3 million.

Here’s what most investors overlook: the report also showed that Leo’s current property isn’t sheltered at all. He’s earning an after-tax return of roughly 3% on the building. If he simply holds the property, he’d pay an additional $480,000 in taxes over the next five years just on the rental income. The building is generating income, but the tax drag is significant.

Leo has definitely decided to sell. But the question isn’t whether to sell—it’s what to do with the proceeds.

The “Pay the Tax, Invest at a Higher Return” Scenario

Leo’s original plan assumed he could earn 9% on the after-tax proceeds from his $5 million in boot—fully taxable income—and beat what a DST portfolio would return at 4.5% cash flow.

After 14 years in that scenario, Leo would have earned about $1,050,000 more in after-tax income compared to a full DST exchange.

Sounds like a win, right?

But Leo also paid $1.3 million in taxes to get there. After 14 years, accounting for the taxes paid upfront, he’s still roughly $250,000 in the hole compared to a full exchange. The taxes are what make it so difficult for another investment—even one with a higher nominal return—to outperform tax-deferred real estate.

What a Full 1031 Exchange into DSTs Would Look Like

If Leo exchanged the entire $7 million into multi-family DSTs paying 4.5% cash flow, he’d receive approximately $300,000 per year in distributions—and pay zero income tax on that cash flow for at least the first five years, thanks to depreciation sheltering.

That’s $300,000 a year, tax-free, with no management responsibilities. For an investor focused on legacy and long-term wealth, that’s a powerful position.

What About Taking $5 Million in Boot?

Exchange Planning Corporation also ran a report showing what happens if Leo takes $5 million out of the exchange and only reinvests $2 million into DSTs.

The results were striking. Not only would his DST income drop by $900,000 over five years (because he’s investing less), but he’d also owe approximately $810,000 in taxes on the boot itself. And the income earned on that $5 million in a taxable investment? Another $870,000 in taxes over the same period.

That’s a total of roughly $1.65 million in additional taxes—just for choosing to take the money out.

This is the math that changes minds. It’s not that taxable investments can’t earn higher returns. It’s that the tax cost of getting the money out, combined with the ongoing tax on the income it earns, creates a gap that’s very hard to close.

The Smaller Boot Option

On the other hand, the same report showed that if Leo took $1.3 million in boot, the total tax would be about $220,000. The tax rate is lower because Leo is taking less money—and he’s paying the tax at a lower marginal rate.

Leo saves taxes in two ways: he took less money, and the money he did take is taxed more favorably. That’s a very different outcome than the $5 million boot scenario.

So What Will Leo Do?

We bet you’re getting curious. Leo’s choice might seem obvious at this point—but we can’t tell you what Leo decided, because Leo is hypothetical.

What we can tell you is that almost every person Exchange Planning Corporation talks to about a 1031 exchange ends up investing at least most—if not all—of the money into a new property. Whatever the client decides to do, they are always thankful that their advisors sent them to Exchange Planning Corporation to make sure they understand the tax consequences of their plan.

These are estimates made for comparison. We use the same variables across scenarios to give investors an apples-to-apples view. Exchange Planning Corporation is not trying to predict what will happen over the next 14 or 15 years—we’re showing you what the math says today so your clients can make an informed decision.

Want to see these calculators in action?

Join Exchange Planning Corporation for a live walkthrough of our 1031 exchange planning calculators. Ask eight questions your client already knows the answers to—and get a complete tax picture in under 25 minutes.

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Frequently Asked Questions

What is boot in a 1031 exchange? Boot is any cash or value received during a 1031 exchange that isn’t reinvested into replacement property. Boot is taxable—and the tax rate depends on how much you take and your overall income. Taking less boot often means a lower rate on the boot you do take.

Can I do a partial 1031 exchange and still save on taxes? Yes. A partial exchange defers taxes on the portion you reinvest. But the boot you take is subject to capital gains tax, depreciation recapture, and potentially the 3.8% Medicare tax. Exchange Planning Corporation’s calculators can model different boot amounts so you can see the exact trade-off.

How do Exchange Planning Corporation’s calculators work? You ask eight questions your clients already know the answers to, and Exchange Planning Corporation generates a full analysis: estimated tax, the cost of holding versus selling, and a side-by-side comparison of different replacement property scenarios — including how leverage and property choices impact future tax savings. The tools are free at 1031TaxHub.com. We handle the analysis—you just ask the questions.

Why does tax-deferred real estate outperform higher-return taxable investments? Two reasons. First, you avoid a large upfront tax bill—so more capital stays invested from day one. Second, ongoing income from DSTs can be sheltered by depreciation for years. A taxable investment earning 9% has to overcome both the upfront tax and the annual tax drag—which is why the math often favors exchanging.