1031’s Blog

What Investors Need To Know About 1031 Exchanges Fees

February 13, 2009 at 10:25 pm | In 1031 exchange |
Tags: 1031 exchange, 1031 exchanges, 1031 tax exchange

The general rule when it comes to 1031 exchanges is that all proceeds from the sale must be reinvested in the replacement property, but as a property investor you likely have experience with the other costs associated with closing on a sale, including your real estate agent’s commission, the recording of the deed, and know that some of your proceeds must be put towards these sorts of transactional expenses.

But what about expenses that don’t necessarily fit into your typical closing statement, a classic example of which being rent proration and security deposits on the sale of a relinquished property?

The correct way to go about transferring future rent and security deposits to the new owner of the property is to cut a check from your own expense account. If you debit these kinds of expenses to your closings statement, you are effectively freeing money in your account for your own use and taking what as known as boot from the proceeds of the transaction. Any cash benefit or boot you receive from the sale is not considered part of a like-kind exchange, and investors who have attempted this have found themselves facing IRS litigation.

Section 1031 operates under the assumption that the investor is transferring the entirety of the equity on the sale property to the replacement. It is unacceptable to debit expenses such as rent proration or security deposits to the closing statement as that frees money in your operating account for your use. Any cash benefits or proceeds that you receive in this context are referred to as boot, and because they are not part of a like-kind exchange are taxable.

The fact of the matter is that the IRS examines these sorts of transactions, and will not look kindly on your receiving non-like-kind proceeds or cash benefits from 1031 transactions. With this in mind, you should be wary and take care regarding what expenses end up on your closing statement.

United States property investors can save big money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is almost like getting an interest free loan from Uncle Sam!