Some experts argue that using exchange proceeds to pay costs related to financing will not violate the 1031 rules if obtaining a loan is a necessary and express condition in closing the real estate acquisition. Loan acquisition fees (such as points, mortgage insurance, application fees, lender’s title insurance, assumption fees, appraisal fees (specifically for loans), hazardous waste/property inspections (required by the lender).Loan related fees/costs: Likewise, based on limited available guidance on the issue and past IRS positions, the consensus among many tax experts is that the following costs related to obtaining a loan, are not allowable exchange expenses which should not be paid out of the exchange proceeds: What Costs Aren’t Allowable Exchange Expenses? The above list is not intended to be exhaustive and there could be other expenses that may qualify. In other words, it can be capitalized – added to the taxpayer’s adjusted basis for the property. In general, experts agree that an allowable expense should be any cost that reduces realized and recognized gain. These expenses are some of the more typical costs related to the disposition of real estate. Other due diligence costs if related to acquisition and not a lender’s requirement.Appraiser’s fees if related to acquisition due diligence and not a lender’s requirement.Other costs specifically related to the transaction, such as Qualified Intermediary fees.Legal fees specifically related to the sale and purchase of exchange property.In the exchange context, there are three potential cost categories that can overlap, but have different implications: 1) allowable expenses (do not violate rules and do not trigger a tax consequence 2) expenses that aren’t allowed and are treated as boot (can both trigger a tax consequence and violate 1031 rules – arguably invalidating part or all of an exchange) and 3) excepted transactional items, which are allowed and will not invalidate the exchange but are “boot” (taxable gain).īased on available guidance, and a consensus among tax experts, the following typical costs related to the disposition of real estate are allowable exchange expenses that can be paid out of the exchange proceeds in relation to relinquished or replacement property:
In most cases, the consequence is likely the payment of tax and penalty on the amount at issue, rather than disallowance of the entire exchange. However, there is still a risk that a taxing authority could take issue with the use of exchange funds to pay for non-exchange costs. In general, it is rare that a taxing authority closely examines the settlement statement or closing disclosures. Many 1031 exchanges are handled incorrectly with respect to transactional items because there is often little or no consequence for the improper handling. While this short summary will briefly mention some existing rules/guidance/cases, it is important to note that in reality, custom and practice often deviate from these rules. The answer to this question is “it depends.” For some items, the guidance is pretty clear and for other items, the answer is open to interpretation due to the existence of limited IRS guidance. Pajonas, Esq., President, Legal 1031 Exchange Services, LLC Walther, Esq., LL.M., General Counsel, and Todd R. Ouchi (Eds.), Organizational economics (pp.
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