If you are preparing to sell an investment property via 1031 exchange and have spent money on repairs prior to closing, you may be wondering: Can I get reimbursed for those costs using 1031 exchange proceeds?
The short answer is, “not directly.” But there are a few strategic options that may allow you to recover those costs without jeopardizing your like-kind exchange.
Why Pre-Closing Repairs Don’t Typically Qualify
In a 1031 exchange, certain transactional costs can be paid from exchange proceeds without creating a taxable event. Pre-closing repair costs are not generally considered allowable exchange expenses under Treasury Regulation §1.1031(k)-1(g)(7). However, if the repairs are made pursuant to a buyer-negotiated concession that is documented in the purchase agreement and reflected on the settlement statement, they may be treated as a seller obligation rather than personal reimbursement.
This distinction matters because expenses that fall outside the allowable category could trigger “boot,” or taxable income, which diminishes the tax-deferral benefit of the exchange.
Option 1: Accept Some Taxable Boot
One approach is to allow some boot at closing to reimburse yourself for those pre-closing repairs. While that portion would be taxable, it may not significantly impact your overall tax situation. In many cases, these repair costs are tax deductible in the year they were incurred, which could offset the tax liability, potentially making it a “wash.”
Before going this route, consult with your CPA or tax advisor to confirm whether this partial approach aligns with your broader tax picture and the nature of the expenses.
Option 2: Do a Full Exchange and Refinance Later
If your goal is to complete a 100% tax-deferred exchange, another option is to delay reimbursement. Instead, you could complete your exchange in full, then later refinance the replacement property through a separate loan transaction. This allows you to pull out equity and repay yourself for the earlier expenses without affecting the integrity of the exchange.
What Costs Can Be Paid from 1031 Exchange Proceeds?
Under Treasury Regulation §1.1031(k)-1(g)(7), several transactional expenses are recognized as safe to pay using 1031 exchange funds. Typically, these are typically costs that:
Are customary in local real estate closings,
Appear on the settlement statement, and
Relate directly to the sale of the relinquished property or the purchase of the replacement property.
Examples include:
Broker commissions
1031 exchange intermediary fees
Title insurance premiums
Escrow and closing fees
Appraisal fees (if required by contract)
Transfer taxes
Recording fees
Professional fees (CPA, attorney, or financial advisor) directly tied to the sale or purchase
These costs are supported not only by Treasury regulations but also by long-standing IRS guidance, including Revenue Ruling 72-456 and IRS Private Letter Ruling 8328011.
Connect with a 1031 Exchange Qualified Intermediary
Pre-closing repairs that are not made pursuant to a contractual requirement negotiated as a concession with the buyer, don’t fit neatly into the list of exchange-approved expenses. However, with smart planning, whether accepting some taxable boot or structuring a post-exchange refinance, it may still be possible to recoup those costs without completely undermining the benefits of your 1031 exchange.
As always, the key is consulting with a tax professional who understands the nuances of 1031 exchange rules and can guide you toward the most advantageous strategy for your situation.
Thinking about a 1031 exchange? Feel free to call me, Jeff Peterson, at 612-643-1031, or email me at jeffp@CPEC1031.com.
Defer the tax. Maximize your gain.
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