What to Know About Closing Costs
There are always questions from taxpayers as to which closing costs can be paid with sales proceeds when doing a 1031 Exchange. Just like with other 1031 issues, there isn’t much guidance on this topic from the IRS. Please consider this article as a guide on the subject, but always consult with your tax professional for specific guidance.
Per the 1031 code, certain expenses paid at the closing of your sale or purchase that are considered “exchange expenses” should be allowable; avoiding any tax liability. Most tax professionals familiar with 1031 Exchange transactions believe that the following can be paid at the closing while avoiding any tax burdens:
- Broker’s commissions
- Qualified Intermediary fees
- Escrow fees
- Title insurance fees for the owner’s policy (not for the lender’s policy)
- Transfer taxes and recording fees
- Attorney’s fees (specific to the transaction)
- Appraisal fees (if required in the Purchase and Sales Agreement, not a lender requirement)
These fees are normally considered allowable as they are one-time costs for the specific transfer of the property.
Below is a list of costs that may be seen on a standard closing statement when selling or purchasing property. These costs are normally considered non-allowable under Section 1031:
- Loan costs and fees (i.e. Loan origination, points, etc.)
- Title insurance costs for the lender’s policy
- Any other lender required fees (i.e. appraisals or Phase 1 studies)
- Insurance premiums
- Property taxes
- Transfer of Security Deposits
- Transfer of Prorated Rents
In general, tax advisors will take the opinion that fees associated with getting a loan on your replacement property are costs of acquiring a loan, not costs of the acquisition of replacement property. Therefore, those costs are not generally considered allowable. As a taxpayer doing a 1031 exchange, they may wish to use 1031 funds for those costs. If so, they would most likely create a tax liability on those expenses. To avoid that liability, the buyer should deposit funds with the settlement agent from out of pocket funds to cover those amounts.