Allowable Closing Costs in a 1031 Exchange

One area where taxpayers can potentially slip up during the 1031 exchange process is closing costs. There are certain items that are allowable as closing costs and other items that are not. Knowing the difference is essential to the success of your like-kind exchange. In this article, we are going to discuss allowable closing costs in a 1031 exchange of real estate.

Allowable Closing Costs

In a 1031 exchange, not all closing costs can be paid with the exchange funds. The following is a list of all the allowable closing costs in a 1031 exchange:

• Broker’s commissions;

• Real estate agent commissions;

• Title transfer taxes;

• 1031 exchange facilitator fee;

• Owner’s policy title insurance fees;

• Escrow fees;

• Attorney’s fees; and

• Title recording fees

Non-Allowable Closing Costs

Here are a handful of closing costs that should NOT be paid using the 1031 exchange funds:

• Costs and fees associated with acquiring loans;

• Security deposits;

• Prorated rents;

• Insurance premiums;

• Property taxes;

• Fees associated with lender’s title insurance;

• Lender’s appraisal fees; and

• Lender’s inspection fees.

• Paying Tax with Exchange Funds or Outside Funds

It’s important to pay these costs in cash and not using the 1031 exchange funds, as doing so could threaten to derail your exchange

Tax Deferral with Like-Kind Exchanges

A like-kind exchange offers many benefits to the taxpayer – the biggest of which is capital gains tax deferral. As long as you move all of your exchange funds into a new replacement property, you can defer a hefty capital gains tax bill. This keeps your money working for you in a continued investment property. At CPEC1031, we offer like-kind exchange services to taxpayers throughout the United States. Give our like-kind exchange professionals a call today to structure your 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

What Closing Costs May be Paid as Part of a 1031 Exchange?

You may use your 1031 funds to pay certain customary “transactional items” that relate to the disposition of the relinquished property or to the acquisition of the replacement property and that appear under local standards in the typical closing statements as the responsibility of a buyer or seller (e.g. commissions, prorated taxes, recording or transfer taxes, and title company fees).

Oddball Fees

Because there is potential for ambiguity as to what is a customary or qualifying transactional item, oddball fees and questionable transactional expenses that may not customarily be paid as part of a closing in the locality where the properties are located, should be paid out-of-pocket (not from the 1031 funds) to eschew any potential challenge.

From the IRS

Page 12 of IRS publication 544 states that:

Exchange expenses are generally the closing costs you pay. They include such items as brokerage commissions, attorney fees, and deed preparation fees. Subtract these expenses from the consideration received to figure the amount realized on the exchange. If you receive cash or unlike property in addition to the like kind property and realize a gain on the exchange, subtract the expenses from the cash or fair market value of the unlike property. Then, use the net amount to figure the recognized gain.

Your qualified intermediary probably cannot be 100% sure that ALL of your transactional expenses will qualify to be paid from the 1031 funds. However, I suspect that your CPA or accountant will have a much better feel for what is a permitted typical cost or what is a qualifying expense.  After all, your CPA or accountant is the person who will actually sign-off on your tax return and they probably know your specific tax-situation better than anyone else.

• Start Your 1031 Exchange: If you have questions about closing costs in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

How to Avoid Boot on the 1031 Closing Statement

Many closers and title professionals have questions about what expenses to put on the closing statement and what to keep off the closing statement so that the parties don't trigger boot. Here are a few tips for avoiding boot on the closing statement during a 1031 exchange.

3 Things to Remember

On the sale of the old relinquished property closers need to be careful about the security deposits that must be paid over from the seller to the buyer. Further, they need to be careful about the rents that have been collected by the seller, and which in-part need to be paid over to the buyer for those days that the buyer will own the property during the month for which the rents have been collected. Finally, closers need to be really careful about tax prorations, charges against the seller for real estate taxes that would normally be paid by the seller out of their operating account.

Dealing with these Expenses

So what's the most proven way to deal with these expenses on the sale of the relinquished property? It's to have the seller pay to the buyer or wire transfer money to the title company for those amounts and show them as paid-outside-of-closing (“POC”). That way all of the equity from the sale of the relinquished property can be moved into the new replacement property.

There are also some closing costs on the replacement property you need to be careful about, in particular any costs related to the new mortgage or deed of trust on the replacement property. Ideally the taxpayer (the buyer) doing the exchange will either get a no-cost loan from their lender, or will pay those loan origination fees and other loan related expenses out-of-pocket, rather than utilizing the exchange funds to pay for the lender costs.

• Start Your 1031 Exchange: If you have questions about avoiding boot on the closing statement, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Whiteboard Video - Title Closers & Closing Costs in a 1031 Exchange

In this whiteboard animation video, we discuss the various expenses that title closers need to be aware of in a 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 closing expenses, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved