What 1031 Exchange Expenses are Added to Basis?

Posted Jan 14, 2024

A picture of a hand typing into a calculator trying to calculate 1031 exchange expenses.

When it comes time to sell real estate you might use for business or investment, you could defer capital gain and depreciation recapture taxes with help from 26 U.S. Code § 1031 – “Exchange of Real Property Held for Productive Use or Investment.” When you follow the IRS rules for a 1031 exchange, you “swap” real estate you currently own (relinquished property) into different real estate (replacement property).

While the like-kind exchange can be straightforward, it comes with stringent deadlines, regulations, and requirements. One of those requirements is understanding the basis of the relinquished and replacement properties. Also essential? Knowing what exchange expenses can be added to the basis of the replacement property.

Quick Review: Defining the Basis

Whether your real estate is for personal use or has a role in your investment strategy, you’ll run into the concept of “basis.” Sometimes known as “cost basis,” this is the amount you invest in a property plus out-of-pocket expenses or closing costs related to the property’s acquisition. These additional costs might include broker commissions, title insurance fees, or closing costs.

Then, there is the adjusted basis, which happens once you own the property. This might include capital improvements, depreciation deductions, or casualty or theft losses.

To preserve the deferred capital gain for potential recognition in the future, that basis carries over from the relinquished property to the replacement property.

Expenses and the Replacement Property Basis

However, additional expenses can be added to the basis of your replacement property or properties. In addition to the purchase price, these might include the following:

  • Transfer taxes, which states or municipalities might impose to transfer property titles or other paperwork
  • Legal fees, as assessed by your attorney
  • Brokerage commissions if you use a real estate broker to help handle the exchange
  • Qualified Intermediary fees, which are paid to the QI that manages your like-kind exchange
  • Land surveys, appraisals, or inspections that might be needed during the escrow/due diligence process
  • Other costs, including title insurance, escrow, and recording fees

Record and Experts

It’s essential to keep thorough records of all costs and expenses involved with the exchange, even after it’s closed. Those expenses will be necessary when you sell that replacement property down the road. Given the many expenses connected with the purchase, sale, and ownership of property, it’s essential to understand what costs are assigned to basis and which are reported as other expenses.

Furthermore, many states have their own laws pertaining to real estate taxes and like-kind exchanges. Those state laws – and the federal laws as well – are always subject to change. Because of this, it’s essential that you work with tax experts and qualified intermediaries who are familiar with these regulations to help ensure a successful 1031 exchange.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.

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