How to Avoid Boot on the 1031 Closing Statement

avoiding boot on the 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.

Pro Tip

Here's an interesting trick that some taxpayers can utilize: the buyer on a replacement property will extract a concession from the seller where the seller agrees to pay for up to $5,000 of the buyer’s closing costs and prepaid expenses. Then the buyer moves those charges that are related to the lender fees off of their side to the closing statement and on to the seller side pursuant to that concession so the seller ends up paying for those costs rather than the buyer.

When in doubt, it’s always better to pay questionable transactional expenses out-of-pocket rather than dipping into the exchangor’s 1031 funds.

Also, it’s a good idea to ask the exchangor’s accountant or CPA to review and comment on the closing/settlement statement before the closing is completed, because once the closing is done it’s too late to change the disbursements.

  • 1031 Hotline: 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.

 

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