Can You Pay Closing Costs With 1031 Proceeds?

The better question is…can I pay closing costs with 1031 exchange proceeds and avoid boot. The answer is yes.

Although the IRS is often quite draconian when it comes to disallowances surrounding a 1031 exchange, when it comes to paying closing costs they are a bit more lenient. The IRS stipulates that in order for closing costs to be paid for with exchange funds, the costs must be considered a “Normal Transactional Cost.”

These Normal Transactional Costs (also called Exchange Expenses) are classified as a reduction in boot and an increase in basis. Any costs outside these Normal Transactional Costs are considered taxable boot to the investor, and taxes are immediately due on those values.

Normal Transactional Costs include sales commission, legal fees, finder’s fees, escrow fees, inspection/testing fees, transfer tax, title insurance fees, recording fees, property taxes, exchange fees, messenger fees, document fees, statement fees, tax service, processing fees and notary fees.

Non-Exchange Expenses include rent proration, utilities, points, mortgage insurance, property liability insurance, application fees, lender’s title insurance, assumption fees, homeowner dues, repairs/termite work, security deposits, replacement property loan acquisition fees.

Note that there are a few fees that may be eligible for consideration as a Normal Transactional Cost, depending on the circumstances. These include appraisal fees and inspection/testing fees.

To learn more about 1031 exchanges or our qualified intermediary and replacement property locator services, please visit our website.