Business Management

1031 Exchange: What Investors Should Know About Closing Costs

9 Articles Written

When planning for a 1031 exchange, it’s important to have a target reinvestment amount. Why? Because to defer all tax in a 1031, you must purchase at least as much replacement investment real estate as your net sale.

But… what is the net sale? Well, the easy answer is the contract price minus closing costs and commissions. So which closing costs count in this equation?

Frankly, as in many aspects of the 1031 exchange, there isn’t a crystal clear answer to that question.

Here’s how the tax code on this subject reads.

“Items that a seller may receive as a consequence of the disposition of property and that are not included in the amount realized from the disposition of property (e.g., prorated rents), and (ii) Transactional items that relate to the disposition of the relinquished property or to the acquisition of the replacement property and appear under local standards in the typical closing statements as the responsibility of a buyer or seller.”

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

See what I mean? Because the language of the code is open to interpretation, there is room for error. Consequently, you can read “error” as “taxable gains.”

Related: The Ultimate Guide to Real Estate Taxes & Deductions

calculator with less tax and more tax buttons

1031 Exchange Eligible Expenses

Fortunately, the IRS provides examples of qualified 1031 exchange expenses. Referred to as exchange costs, the IRS allows payment with exchange funds. That’s because these costs are considered typical closing costs related to the sale of property. As a result, using exchange funds to cover these costs won’t result in tax penalties or the disqualification of your exchange.

Exchange costs include:

  • Escrow fees
  • Broker’s commissions
  • Mandatory appraisal costs (purchase contract only)
  • Attorney costs related to the sale
  • Recording fees
  • Title insurance costs
  • Transfer taxes
  • Prorated taxes
  • Qualified intermediary fees

Expenses Not Covered by 1031 Exchange Funds

While there are some expenses that you can clearly use exchange funds to cover, there are others that are not eligible.

Exchange funds do not cover: 

  • Costs of financing
  • Prorated rent
  • Security deposits

Related: How a 1031 Exchange Can Make You Millions

closeup of hand using scissors to cut paper that reads taxes

If you use exchange funds to cover these types of costs, then the IRS treats them as cash taken out of the exchange. This is known as “boot.”

As a result, this boot portion of your proceeds becomes taxable. Consulting with an experienced qualified intermediary (QI) will reduce the likelihood of simple mistakes like this being made.

Also, you should avoid using exchange funds to cover:

  • Property taxes
  • Appraisals required by a lender
  • Insurance premiums

These are typically expensed costs and therefore not included on a closing statement.

In addition, take care not to use exchange funds to pay for anything between the sale of your property and purchase of your reinvestment property. This avoids a “constructive receipt” of funds issue.

Instead, pay these out of pocket. This includes lender lock-in fees. Exchange funds and loans do not mix!

The Bottom Line

With this in mind, take advantage of every allowable 1031 exchange cost at closing. Involve your tax professional and qualified intermediary in determining which costs may be paid with your exchange proceeds. They will be able to tailor their guidance to your particular situation.


Legal Information Institute. “26 CFR § 1.1031(k)-1 – Treatment of deferred exchanges.” Accessed 01 July 2019.

Government Publishing Office. “CFR-2011-title26-vol11-part1-subjectgroup-id46.pdf.” Accessed 01 July 2019.

Do you have any other questions about 1031 exchanges? 

Ask me in the comment section below!


Dave Foster, real estate investor and qualified intermediary, has 20 years of experience working in all phases of real estate investing, from large scale development to single family homes and vaca...
Read more
    Deanne Bourne Investor from Concord, California
    Replied 7 months ago
    Your intermediary should be able to get the 1031 done correctly. Plus don’t you just pay taxes on the amount that isn’t committed to the new property. Say you make a $2000 mistake and the new property costs are cheaper than the one being sold; don’t you just see that $2000 as a taxable gain (boot) or do you lose the whole effort of the exchange?
    Dave Foster Qualified Intermediary for 1031 Exchanges from St. Petersburg, FL
    Replied 7 months ago
    Great comment Deanne, And you’re absolutely right. You would only pay the tax on the difference between your net sale price and the net purchase price if the net purchase price was smaller. Because of this many of our clients choose to let their exchange pay for all closing costs on the settlement statement. And their accountant then makes any adjustments for disallowed closing costs when they report the exchange on the clients tax return. D
    Sergio Francis Investor from Washington, District of Columbia
    Replied 7 months ago
    Thanks for the information. I am strongly considering doing a 1031 soon
    Dave Foster Qualified Intermediary for 1031 Exchanges from St. Petersburg, FL
    Replied 7 months ago
    So glad it was helpful Sergio. Hopefully we can work together. D
    Katia May Rental Property Investor from Philadelphia, PA
    Replied 2 months ago
    Hi David, I am going to sell a rental condo in PA and want to buy a house to rent in FL (Delray Beach). Can you recommend a good intermediary in PA (preferably Philadelphia area)? Also when I buy the house in FL how long time I will have to rent it? What if it takes couple months to find somebody to rent the house? Thanks. Katia
    Dave Foster Qualified Intermediary for 1031 Exchanges from St. Petersburg, FL
    Replied 2 months ago
    Hi Katia, Thanks for reaching out. The qualified intermediary for 1031 exchanges is rarely local to the transaction. Since the QI must be an unrelated party to the client it is difficult to develop a scale of business if that's all you do because of the limited pool of 1031s in any specific location. So most QIs operate nationally. Additionally it is just as common for a 1031 to start in one state and end in another. So your QI is going to have to have an understanding of two states anyway. It's better to search for a QI by depth of experience and personal vetting. Being a competent QI involves an in depth knowledge of an incredibly complicated statute. Not may want to specialize in it. So the best ones are almost always going to be those with a national reach.