As you likely know, entering a 1031 exchange provides benefits like tax deferral and access to new asset classes. However, this transaction still involves the need for services, special procedures, and professional guidance. Expenses are unavoidable.
Knowing the specific costs involved helps you understand where your money is going and how the reduction in proceeds affects property replacement requirements. Below, Realized 1031 shares a comprehensive guide on these costs to help you gain insights. Keep reading to learn more about 1031 exchange closing costs, professional fees, and other associated expenses.
Common 1031 Exchange Costs and Fees
Here are some of the most common costs and fees involved in 1031 exchange transactions.
Qualified Intermediary Fees
Engaging with a qualified intermediary is required in all 1031 exchanges since you’re not allowed to have direct control of funds. This entity is also the party that oversees the entire exchange and ensures that you remain compliant. These services, predictably, mean fees.
A typical qualified intermediary will require the following:
- A flat base fee for the exchange
- Additional fees for multiple replacement properties
- Wire transfer and document processing fees
In terms of flat fees, expect the range to be between $750 to $1,200, with additional costs for more specialized services or additional replacement assets.
Closing Costs of Relinquished Property
While not officially part of the exchange, the sale of your relinquished property also contributes to your total expenses. A few additional closing costs include commissions for the real estate broker, escrow and title fees, and attorney or settlement fees. Some costs can be deducted from the proceeds without triggering boot, and some reduce the equity of the asset for reinvestment.
Closing Costs of Replacement Property
When finishing the exchange by acquiring a new asset, the transaction also involves some expenses. These include closing costs like title insurance, recording costs, and professional fees or commissions. As a buyer, you may also need to conduct additional due diligence steps like inspections, which will naturally cost money. However, these expenses are necessary to provide assurance on your end as the buyer.
While expected, these costs still reduce the cash applied toward the purchase and so must be accounted for when calculating how much value you need to replace.
Financing or Debt Service Fees
There are cases when financing is necessary to acquire the replacement asset, especially if its value is higher than the relinquished asset. Debt services will have their distinct costs apart from the interest and principal payments. These fees include loan origination fees, appraisal costs, and lender legal fees.
Legal, Tax, and Advisory Fees
Given the complex nature of 1031 exchanges, qualified intermediaries are not the only professionals you’re going to work with. Many investors work with tax attorneys, CPAs, and exchange advisors to structure transactions properly and ensure compliance with 1031 exchange rules. For example, tax planning consultations will be necessary for tracking the capital gains taxes deferred, particularly for 1031 exchanges that have been through several cycles.
Unlike the expenses above, these fees are usually paid out of pocket and may not necessarily be included as a deductible expense for the exchange itself.
Fees for Specialized Exchanges
Specialized 1031 exchanges might entail unique or additional fees. Reverse exchanges, wherein the acquisition of the replacement property happens first before the disposition of the relinquished asset, require higher fees due to the added complexity. Exchanging more than one property (following the 200% rule) will also entail additional closing costs for each separate asset.
The Effects of 1031 Exchange Expenses on Property Replacement Requirements
IRS rules require investors to acquire an asset that has equal or greater value than the relinquished property. As such, determining the final amount is crucial for avoiding taxable boot. Some 1031 exchange costs and fees can complicate this calculation. As these expenses reduce the net proceeds, you may need to find additional resources to acquire the asset you identified. On the bright side, these costs lower the total amount you need to reinvest, reducing the chances of having a taxable boot.
Keep in mind, though, that not all expenses during the exchange are allowed as deductions. Professional fees for tax planning or exchange guidance, as we highlighted above, are often not included. Make sure to consult with 1031 exchange experts to determine which are allowed in your exchange to ensure that you remain compliant.
Wrapping Up: Understanding the Cost of a 1031 Exchange
The nature of a 1031 exchange entails services and processes that cost money. These include qualified intermediary fees, closing costs, and professional advisory fees. Knowing which can be deducted from the realized gain is important, as the calculation can affect how much proceeds you can reinvest when acquiring the replacement property. This knowledge helps you plan more strategically and protect more of your equity.
Sources:
https://www.investopedia.com/terms/r/reverse-exchange.asp
https://www.irs.gov/businesses/corporations/qualified-intermediary-program
