When engaging in a tax deferred exchange under IRC Section 1031, it is important to understand the proper treatment of transaction expenses, including which expenses can be capitalized as qualified exchange expenses. This involves not only the sale of the original property held but also the purchase of the new property. The following is a brief guide to help in understanding both sides of the transaction and the proper classification of costs.
Sale of Relinquished Property
This is the property given up in the exchange. Qualified exchange expenses can be used to reduce the sales price of the relinquished property in order to lower the reported amount of net cash received in the exchange transaction.
Purchase of Replacement Property
This is the property acquired in the exchange. Qualified exchange expenses can be added to the purchase price in order to increase the reported amount of net cash paid in the exchange transaction.
Qualified Exchange Expenses
The following are common exchange expenses that can be capitalized in both the sale of the exchange property and purchase of replacement property in the manner discussed above:
- Intermediary fees
- Title insurance
- Commissions
- Recording fees
- Legal fees
- Tax certifications
- Surveys
Non-Deductible Expenses
The following are common costs of a transaction that cannot be capitalized with either the sale or purchase but, rather, should be recorded in the ordinary course of business:
- Prorated rental and other income
- Prorated property taxes
- Lender or utility reserves
- Insurance premiums
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For more information on this topic, please contact a member of Withum’s Real Estate Services Team.
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
