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When entering into a 1031 exchange one often does not consider the ancillary costs that come with closing the transaction. Often the assumption is made that these costs will be subsidized by the 1031 exchange proceeds. However, while some of these costs certainly can be bankrolled by the tax deferred exchange, some cannot. Knowing how to avoid these expenses being deemed boot can keep your transaction out of hot water.

Covered Costs:

It is generally acknowledged that “payment of brokerage commissions from exchange proceeds does not create taxable boot.” Thus, payment of these “non-recurring” costs of sale or purchase from the exchange proceeds should not be considered taxable boot. Brokerage commissions are one example of non-recurring costs; however certain other costs are excluded.

They are as follows:

Real Estate Commissions
Recording Fees
Direct Legal Fees
Title Insurance Premiums
Qualified Intermediary Fees
Agreed Property Inspections
Escrow or Closing Agent Fees
Documentary Transfer Fees

Note: Expenses have to be customary in the jurisdiction (e.g. 6% listing agreement).

Un-Covered Costs:

Certain costs are generally not covered and considered taxable boot if they are involved with anything else besides acquisition of the replacement property. The issue most people run into involves getting a new loan on the replacement property. Because the costs for acquiring the new loan are not related to the acquisition of the replacement property (according to the IRS), they are considered taxable boot.

These Include:

Loan Fees
Prorated Mortgage Insurance

Another issue to consider is that prorated property taxes, insurance payments and rents are considered deductible ongoing expenses. As such, they are not included in the 1031 exchange; however, their payment does not impact the use of the Qualified Intermediary safe harbor.

Featured Exchange Counsel
  William Gessner, Esq.
Senior Exchange Counsel
11150 Sunset Hills Road
Suite 300
Reston, VA 20190
Direct 301.651.3445
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