closing costs

How to Account for Fees Associated with your 1031 Transaction

1031 Exchange Fees

Many taxpayers who are in the middle of a 1031 exchange have questions about how to account for fees associated with the 1031 transaction.

Specifically, can any of the following be included on the settlement statement?

  • Lender Legal Fees
  • Appraisal Fee
  • Appraisal Review Fee
  • Flood Certification

Fees that Cannot be Paid with Exchange Funds

On the closing of the replacement property certain fees associated with the new loan may not be paid with exchange funds without potentially triggering the recognition of gain (which would result in a failed 1031 transaction).

Any lender required expense ideally would be paid for out-of-pocket and not out of the 1031 exchange proceeds. These include: 

  • Lender Legal Fees
  • Appraisal Fee
  • Appraisal Review Fee
  • Flood Certification

It is not a good idea to put these on the 1031 exchange closing documents. Pay these fees out of pocket, and keep your 1031 funds away from them in order to protect your 1031 exchange. Take a look at our previous article for closing costs that can be paid with 1031 funds.

  • 1031 Hotline: If you have questions about how to account for 1031 exchange fees, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Expenses that Can & Cannot Go on the Closing Statement

1031 transactional expenses

When you're doing a 1031 exchange, the primary goal is to move all of your equity into the new relinquished property. But the exception to that rule is that you can use some of your exchange proceeds to pay customary transactional expenses that would appear in the sold property's locality.

Expenses that Can Go on the Closing Statement

So you can pay your broker commission, and your attorney fees that are related to the transaction. You can pay recording fees and title company charges. You can even pay your qualified intermediary fees. If a termite inspection is a customary transactional expense in the locality, then you can pay that as well on the closing statement.

Expenses that Should Not Go on the Closing Statement

Certain expenses should not be put on the closing statement from the 1031 exchange. For example let's say the seller wanted to put his credit card bill on the sale statement, thinking that “well I had to fix up the property to get it and I charged all of those repairs on my credit card so I think I'm going to pay my credit card bill on the closing statement.”

Well that is not contractually associated with the property and should not be paid on the settlement statement because it doesn't fit into what the treasury regulations require for debt that must be associated with the property, not just mentally but contractually required to have been paid as part of the closing.

Rent, Taxes, Security Deposits

Other transactional expenses that can gum up the works are rent prorations, security deposits, and tax prorations. Each of those items would probably be better paid out of the seller’s pocket rather than dipping into the sales proceeds. Remember, the idea is we want to move all of our equity - all of our net proceeds - into the new replacement property and items that are really operational expenses like taxes and deposits should be paid by the seller out of their operating account.

  • 1031 Hotline: If you have questions about exchange expenses on the closing statement, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

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

closing costs in 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.

  • 1031 Hotline: 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

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.

 

© 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.

  • 1031 Hotline: 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