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Exchange Expense:  How to Keep a 1031 Completely Tax-Deferred

1031 Tax DeferredIn order for an investor to have a completely tax-deferred 1031 exchange, he must use all of the cash from the sale of the relinquished property.  Many of the sale-related expenses and certain replacement property purchase costs can be paid with exchange funds without creating a tax liability.  Non-exchange expenses require payment with the investor’s own funds.

Non-Allowable Expenses and Costs:

Rather than give a buyer credit at closing, the exchange seller should pay the following items with his own funds.

  • Security deposits and prorated rents
  • Prorated real estate taxes

When the taxpayer buys the replacement property, he should pay the following items with his own funds.

  • Insurance premiums
  • Lender-required appraisal and environmental costs
  • Lender’s title insurance policy premiums
  • Loan costs and fees

Allowable Expenses and Closing Costs:

Though official IRS rulings are mostly non-existent, except for Revenue Ruling 72-456 allowing exchange funds to pay broker commissions, tax professionals mostly concur with allowing payment at closing of the following expenses.

  • Real estate broker’s commissions
  • Qualified intermediary fees
  • Owner’s title insurance premiums
  • Appraisal fees required by a purchase contract
  • Attorney fees related to the sale or purchase of the property
  • Recording and transfer fees
  • Tax advisor fees

Issues such as constructive receipt, offsetting certain non-allowable 1031 expenses, and other issues related to use or non-use of exchange funds and the timing thereof, require prior consultation with the investor’s legal and tax advisor well before closing on the property to structure a Section 1031 exchange that is completely tax-deferred.

We would be happy to assist you in this area.

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