Deduction of Closing Expenditures
PLR 8328011 gives some additional guidance to the deduction of exchange expenses from the amount realized in calculating recognized gain. IRS form 8824, which is filed to report an exchange transaction, provides that exchange expenses are utilized in the determination of the amount realized in a taxable sale transaction. Since there is no other authority regarding any other closing expenses, most tax professionals believe that such expenses should include all those that are typically deducted by the seller from the gross sales proceeds in a taxable sale under IRS Code §1001, or capitalized by a buyer and added closing costs to the basis of the property acquired under IRS Code §1012.
Typical closing expenses would include:
Commissions, finder’s fees, inspection and testing fees, transfer taxes, recording fees, legal fees, Qualified Intermediary fees, and escrow and trustee fees. Other expenses, such as the proration of rents, property taxes, utilities and property insurance premiums debited against the taxpayer out of the exchange balance are not closing expenses and should be considered taxable boot to the taxpayer. Also, any loan fees, points, loan application fees, mortgage insurance, lender’s title insurance, assumption fees and other costs related to the acquisition of a loan for the replacement property should not be treated as closing expenses since these costs generally are treated as part of the costs for obtaining the property and do not increase the basis of the replacement property.
Therefore, if the loan related expenses are paid out of the exchange balance, they should constitute taxable boot in the form of cash received by the taxpayer.
In determining what the taxpayer must spend for the replacement property, many taxpayers are under the incorrect assumption that under IRS code §1031, only the proceeds of the sale must be used to purchase a replacement property. In reality, the IRS requires that the taxpayer buy a replacement property or properties, equal to the net sales price of the relinquished property.
Deduction of Closing Expenditures – Capital 1031 Exchange Company