What Investors Need To Know About 1031 Exchanges Fees

There are many expenses involved in the closing of a sale on real estate. There are the standard operating expenses, such as your agent’s commission and the recording of the deed, which siphon money out of your proceeds and appear on the closing statement, but there are also the various oddball expenses that arise during the proceedings, some common examples of which are rent proration and security deposits.

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 deal with these is to write the owner a check from your own operating account. Debiting these expenses to your closing statement would result in a cash benefit in that money in your operating account would be freed for your use, and this money is considered to be boot.

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.

In the real estate business, it is always advisable to take care when dealing with the variety of expenses that arise during a closing, and this is doubly important when making 1031 transactions. Section 1031 is based on the idea of a like-kind exchange, in which you move everything from point A to point B without skimming any kind of cash benefits or proceeds off the top, so it is best to avoid debiting expenses in a way that usurps this premise.

posted Monday, August 30th, 2010
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