Many closers are put in an uncomfortable position because taxpayers have all kinds of credits and debits on their closing statements and the closer is asked if these expenses are permitted transactional expenses that may appear on a closing statement. The closer doesn’t have the tools to answer these questions.
Let’s talk really big picture. On the sale of the relinquished property the taxpayer wants to move all of their equity into their new replacement property. The taxpayer is allowed to pay out of the net proceeds certain transactional expenses like:
- Realtor commissions
- Attorney fees related to the exchange
- Recording fees
- State deed tax
But sometimes the taxpayer wants to put an oddball expense on the closing statement like a bill from home depot or other expenses unrelated to the transaction. Those oddball expenses that wouldn’t normally appear on a closing statement should ring an alarm bell.
The other expenses that might need to be addressed are debits for security deposits, rent proration, and property taxes.
Keep Everything in Separate Accounts
If you think about it, the seller of a relinquished property really should be holding those security deposits in a separate escrow account. Upon closing, those security deposits should be transferred to the buyer. But a lot of time property owners don’t keep separate accounts and instead want to raid the proceeds from the sale of the relinquished property to pay the security deposits over to the buyer.
Remember we’re supposed to move all equity from the relinquished property to the replacement property, and raiding the kitty to pay the security deposits to the buyer could be a taxable event. The same goes for rent proration. If the seller has collected rents for the month, they should be taking the money out of their operating account for the portion of the month that the buyer will own the property.
Oftentimes it’s a good idea to work as much of these details out with the seller and the Qualified Intermediary (“QI”) and then have the seller’s CPA or accountant double-check the debits and reductions for transactional expense before closing. The seller’s CPA or accountant will know their tax situation better than anyone and can weigh in on what should and should not appear on the closing statement. That way if there is ever a question about it at tax time, their CPA or accountant will be aware of the details from closing.
Many people have questions about what closing costs are appropriate and having a good QI as a resource is really important.
- 1031 Hotline: If you have questions about title closers and 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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