What do title closers, escrow officers, and closing attorneys need to know about what closing expenses can be shown on the closing/settlement statement when a taxpayer is selling relinquished property in a 1031 exchange?
Big Picture when you’re Closing the Sale of a Relinquished Property for a Seller’s 1031
The big picture topic here is that all of the net proceeds, all of the seller’s equity, needs to go to the intermediary. Only certain limited transactional expenses may be paid on the closing statement. For example the real estate agent's commission can be paid, the recording fee can be paid, and the title company closing fee can be paid.
Taxes, Rent, and Security Deposits
But more difficult topics can be found on the closing statement when it comes to the tax proration, rent proration, and the security deposit. Those items should be paid out of pocket by the seller and not be paid out of the proceeds from the sale of the relinquished property. The reason is that those amounts should already be in the operating accounts of the seller.
The rents for the month which would have been collected by the seller need to be paid over to the buyer at closing for the days that the buyer will own the property. The security deposits and rent deposits need to be given over to the buyer at the time of closing. And the proration. Taxes are typically paid out of your operating account, not out of sales proceeds. Any days that the seller is obligated to pay the taxes should be paid out of the seller’s pocket, and not out of the sales proceeds. Again, big picture we want to take the net proceeds and move that equity into the new replacement property. We don’t want to raid the net proceeds for expenses that are not qualified for the 1031.
When in Doubt
When in doubt, it’s always better to pay unusual expenses out-of-pocket rather than dipping into the Seller’s sales proceeds and to send as much as possible to the 1031 exchange account.
Also, it’s a good idea to ask the seller’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.
Start Your Exchange: If you have questions about closing on a 1031 exchange, feel free to call me at 612-643-1031.
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