1031 Exchange Guide: Closing & Taxes
Welcome to the final installment of our year long special feature report on the 1031 Exchange! To get the full 2014 Guide to the 1031 Exchange, please see our special reports page or contact Stephanie for back issues of Mobile Quarterly.
The finish line has been crossed: your team has successfully conquered the deadlines, found the perfect replacement property(s) and the clock is ticking down the final weeks and days! What’s left? Closing and taxes. With these two critical topics we draw our 2014 Special Report on the 1031 Exchange to a close. While you should consult with your attorney and your tax advisor/accountant on these topics in depth, we are pleased to present you with a very brief overview from information provided by 1031 Exchange experts and intermediary, IPX 1031, to get you started by identifying the main issue and very briefly guiding you to code and statutes on main topics.
It may be surprising to discover that there is very little in the IRS code or Treasury Regulations about how to treat the wide variety of expenses and closing costs associated with a 1031 Exchange. Utilizing the general rule that the Exchanger must transfer all equity in the Relinquished Property to the Replacement Property the main issue then becomes: whether the payment of typical sale and purchase settlement expenses out of the Relinquished Property sale proceeds (exchange funds) will result in “taxable boot” to the exchanger. While we conclude our four-part special report here, your work isn’t done yet! Be sure to consult with your attorney and accountant on the following, and best wishes to all who undertook the unique challenges and rewards of a 1031 Exchange in 2014!
Treas. Reg. §1.1031(k)-1(g)(7): Payment of transactional items in a P/S typically appearing on closing statements as responsibility of buyer or seller, such as broker commissions, prorated property taxes, recording fees, transfer taxes and title company fees, may be paid from exchange funds and will not be construed as constructive receipt of funds by the Exchanger.
Revenue Ruling 72-456: Transactional costs, specifically broker commissions paid are offset against cash received in computing gain, and are added to the basis of the Replacement Property. Brokers commissions paid on Relinquished Property reduce gain and offset boot, but if paid on Replacement Property they increase the basis of the Replacement Property (as do intermediary fees). Loan fees, points, prorated mortgage insurance, loan appraisal fees and other lender-mandated inspections not under the P/S contract are considered costs of obtaining a new loan and may create taxable boot because they are seen as expenditures for benefits.
TAM 8328011: Prorated property taxes, insurance payments, rents and security deposits are considered outside the exchange should not interfere with safe harbor. Exchanger may credit prorated tax payments or security deposits to the buyer of the Relinquished Property as the equivalent of non-recourse debt. This payment can be netted against liabilities assumed on the Relinquished Property.
Treas. Reg. §1.1031(k)-1(g)(6): Using exchange proceeds for expenses unrelated to the P/S of the exchange properties can not only result in taxable boot but can cause the exchange to fail entirely as a violation. Exchange funds should not be used to pay off any debt, credit line, or credit card that is not secured by the Relinquished Property unless solid documentation exists showing how this debt did service the Relinquished Property.