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The Napkin Test was devised by California tax attorney Marvin Starr of Miller Starr and Regalia, Oakland, California, to provide the exchangor with a simple way to determine if there is the potential for taxable "boot" in an exchange transaction. Although it does not replace an exchange recapitulation worksheet, the Napkin Test can establish the need to seek further assistance from qualified tax or legal counsel.

Boot

Boot is "unlike" property received in exchange for real estate. Cash, personal property, or a reduction in the mortgage owed after the exchange is completed are all boot and are subject to tax. By determining if boot is a problem, the exchangor can restructure the transaction before he is committed.

"Mortgage boot" results when the exchangor reduces the amount of loans or debt by exchanging. If the loan on his original property was $100,000 and the loan on the acquired property is $90,000, there is $10,000 worth of mortgage boot. An easy way to understand mortgage boot is to use a simple loan as an example. If you lend $10,000 to a friend and only require him to pay back $7,000, he will have received $3,000 of income. He will have to pay tax on this income. If you have a mortgage of $100,000 and only have to repay $90,000, you have $10,000 worth of taxable "income".

A Simple Rule to Remember

You may offset mortgage boot with cash, but you cannot offset cash boot with additional mortgage. In the above example, the exchangor can add $10,000 of cash to offset the mortgage boot. However, if the exchangor has $100,000 worth of net equity and trades into a building with only $90,000 of equity, the exchangor receives $10,000 in cash and that cannot be offset with a larger loan.

The Test

The test is simply a matter of determining if the exchangor is trading across or "up" in equity and value. The following diagram is the Napkin Test. It shows Exchangor's property as "A" and the property to be acquired as "B".

	Property A	Property B
Value	$150,000	$225,000
Equity	$50,000	$50,000
Mortgage	$100,000	$175,000

In this illustration, the exchangor is trading "across" in equity and "up" in value so that there is no taxable boot.

Why the name, "Napkin Test?"

Because it was developed on a napkin during a seminar break by Mr. Starr.