1031 Permissible Closing Costs and Boot

[Lori F.]

We have sold our relinquished property in Southern California and are working on the purchase of 2 replacement properties in another state.  This is our first 1031 exchange and I am confused about permissible closing costs and boot. 

1. Is it correct than any non-permissible costs paid at closing from the sales proceeds are considered boot? For example, we paid $2500 for termite work out of proceeds at closing, so is that boot?

2. If we received $30k cash boot at sale of relinquished property, but permissible closing costs were $25k, do the closing costs offset the cash boot, creating a taxable event of just the difference ($5k)?

3. Can permissible closing costs paid out of pocket offset cash boot? For example, we paid our accountant $700 for 1031 advice and wrote him a personal check.

4. Would home staging be considered a permissible closing cost?

5. How about municipal code compliance required at time of sale, like low flow toilets and emergency gas shut off valves?

6. Can permissible closing costs incurred from the sale of the CA property plus the 2 out of state replacement properties be added together to offset the cash boot taken?

7. Is net cash boot federally taxed at 25%, up to the $ amount of depreciation taken?

Thanks!

[Bill Exeter]

Originally posted by @Lori F.:

We have sold our relinquished property in Southern California and are working on the purchase of 2 replacement properties in another state.  This is our first 1031 exchange and I am confused about permissible closing costs and boot. 

1. Is it correct than any non-permissible costs paid at closing from the sales proceeds are considered boot? For example, we paid $2500 for termite work out of proceeds at closing, so is that boot? 

Yes, any net proceeds (cash) used to pay for non-permissible closing/selling expenses/costs is considered to be boot.  The cash proceeds must be used to acquire like-kind replacement property.  The payment of termite work is not like-kind replacement property and will therefore be considered taxable boot.

2. If we received $30k cash boot at sale of relinquished property, but permissible closing costs were $25k, do the closing costs offset the cash boot, creating a taxable event of just the difference ($5k)? 

Did you actually receive the $30,000?  If so, then the selling expenses will not offset the cash boot.  The fact that you received $30,000 means that it is taxable boot. 

3. Can permissible closing costs paid out of pocket offset cash boot? For example, we paid our accountant $700 for 1031 advice and wrote him a personal check. 

No. 

4. Would home staging be considered a permissible closing cost? 

I have seen accountants argue both ways.  It is not a direct cost to sell the property, but rather a cost to get the property ready for sale.  It is similar to repairs, maintenance, etc., made in order to get the property ready for sale. 

5. How about municipal code compliance required at time of sale, like low flow toilets and emergency gas shut off valves? 

No, this is a routine operating cost.  It is not a selling expense.  It is triggered by the sale, but it is not a selling expense.

6. Can permissible closing costs incurred from the sale of the CA property plus the 2 out of state replacement properties be added together to offset the cash boot taken? 

Boot received and boot paid can generally be offset, but only in the same closing transaction. For example, if you determine that you are going to have excess "boot" of $5,000 as mentioned above ($30,000 less $25,000) you can contributed out of pocket cash into the closing transaction that will offset the $5,000 in cash boot received, but it must be contributed into the same closing transaction where the cash boot was paid/generated (e.g., you can't contribute the cash into the purchase closing if the cash boot was received in the sale closing).  

7. Is net cash boot federally taxed at 25%, up to the $ amount of depreciation taken? 

It is first applied toward any depreciation recapture and then toward any capital gain.

Thanks!