Is it OK to payoff a mortgage just prior to doing a 1031 exchange?

[C. J.]

If a mortgage is paid off right before selling the home, can we exchange all the proceeds of the sale with no tax consequences? 

For example, suppose a home is worth $400,000 with a mortgage of $160,000. If the mortgage is completely paid off, then the next day the home sells, can all the $360,00 in proceeds ($400,000 - $40,000 in costs) be used to 1031 exchange with no tax consequences (assuming the next home is worth $360,000 or more)? I'm just wondering if there are any issues (mortgage boot, for example) with paying off a mortgage right before selling and doing a 1031 exchange.

[Wayne Brooks]

@C. J. Yes it’s allowed, but……why? There is no advantage to doing this. There is no “mortgage boot” as long as long as you follow the 2 basic 1031 rules….

-replacement property must cost at least the sale price (less actual selling costs) of the sold property, and

-you use all the cash received from the initial sale

You could simply sell the property with the mtg in place, and use additional cash ($160k)to purchase the replacement property for all cash with no mtg.

If you Only used the $200k cash received from the sale, then yes, you’d need to get a $160k mtg to buy another $360k property…..which is what most people do since they want to/can’t bring additional cash above what they received from the sale.

@Dave Foster can further explain.