In a 1031 exchange, can you escrow funds for post-closing repairs and improvements, or could that be considered boot? That is a good question. First and foremost, you may want to talk with your CPA or tax advisor about this.
1031 Exchange Basics
1031 exchanges are for like kind exchanges of real property for real property, and if you get any other property or cash as part of the exchange (non-like-kind property is called “boot”), then that property or cash may be taxable.
Ideally the repair would be paid for and completed by the seller before you close on the purchase of the replacement property, that way there is no need to hold an escrow for your benefit (to pay for post-closing repairs and improvements).
The risk of escrowing cash for your benefit to pay for post-closing repairs and improvements is that it may be considered taxable boot. The escrow may not be considered like-kind property.
Holdback Credits
Holdback credits do not work. An approach instinctively utilized by many realtors and escrow companies to handle minor repairs to Replacement Property is to have repairs performed at the Seller's or Accommodator's expense after the Replacement Property is conveyed to the Exchanger. This approach does not work because the Exchanger is not receiving like-kind property when the Exchanger receives post-closing repairs.
Treas Reg § 1.1031(k)-1(e)(4) specifically provides that "additional production occurring with respect to the replacement property after the property is received by the taxpayer will not be treated as the receipt of property of a like kind.
Please check with your tax advisor on this issue.
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