Credit/Debit Taxes on 1031 Exchange

[Fausto Carosella]

As I understand it when purchasing a "replacement property" via a 1031 exchange, prorated rent, HOA and specifically property taxes should not be paid with the proceeds of the relinquished property. However what about when a relinquished property has a CREDIT from taxes.... for example the seller of the relinquished property owed the buyer taxes, AND the buyer owed the seller of the relinquished property taxes as well for a net GAIN to the seller.... I'm assuming a check should NOT BE CUT to the seller? but added to the relinquished funds....?

[Dave Foster]

@Fausto Carosella prorations like that are always problematic.  We always request that they be handled outside of closing to provide a cleaner settlement statement for the 1031.  But many times lenders etc require those be on the settlement statement even though technically that would not be a cost of the sale, so not part of the 1031.  But it wouldn't be fun to explain to the irs how you got cash from a sale but it really wasn't from the sale etc.  It's something though that your accountant can explain and probably will account for on the form 8824 to record the 1031.

If the deficit goes the other direction you're really better off keeping that away from the exchange because they're really current expenses that can provide you current year deductions rather than getting capitalized with the property.

It's a dilemma because you'd be technically correct taking the cash difference.  But it makes your accountants job harder.  It's a potential explanation if ever audited.