One of the key concepts when you are completing a 1031 exchange and closing on your new replacement property is to re-invest all of your 1031 exchange funds into your new like-kind replacement property, rather than to pay for non-qualifying transactional expenses.
For example in a real estate exchange, if you use your 1031 funds to pay for a car (which is not like-kind to real estate), then the money applied for the car would trigger the recognition of gain.
Qualifying Transactional Expenses
Taxpayers are allowed to pay for some ‘qualifying’ transactional expenses such as real estate agents commissions, attorney’s fees (related to the 1031 and real estate), recording costs, qualified intermediary fees and customary transactional expenses that would normally appear on closing statement in the area where the property is located.
Non-Qualifying Transactional Expenses
As a pointer for 1031 purposes, when a taxpayer is purchasing their new Replacement Property, the taxpayer/buyer should not use 1031 proceeds to pay for non-qualifying transactional expenses. Instead, he or she should give the seller a separate check (from non-1031 funds) for those costs.
Some of the most common non-qualifying transactional expenses are:
- Costs of assuming or putting on new debt, mortgages or deeds of trust (the IRS looks at the debt like it is a separate non-qualifying asset);
- Charges for rent proration (this is typically an operational expense that should be paid with non-1031 funds);
- Charges for property tax proration (this is typically an operational expense that should be paid with non-1031 funds);
- Large amounts of personal property, such as movable items of equipment and furniture (this is not like-kind property)
The key idea is to apply the full amount of the taxpayer/buyer’s 1031 proceeds to pay the purchase price for the like-kind real estate.
- 1031 Hotline: If you have questions about replacement property closing costs in Minnesota, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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