1031 confusion re: credits

[Allen B.]

I've run into some confusion at the last moment with my 1031 exchange and was hoping to get lucky and catch someone who knows the right answer.

In short, I've got a settlement statement for an occupied multifamily property. That statement shows a price of X (some of which I've paid out of my own pocket as earnest money and wish to have reimbursed from the exchange), plus various expenses. Some of these (various recording fees, attorney fees, transfer tax) are also eligible 1031 expenses. Let's call those Y.

My understanding is that I should be able to use exchange funds for all of X+Y (purchase price plus eligible fees) without incurring tax liability.

Where the confusion comes in is because of credits from the Seller to me. Those credits are prorated property taxes (call it A) plus prorated rent for the month of April (call it B). So naturally, the amount that I owe at closing is reduced by A+B.

However, it does not seem logical that the eligible expenses from the 1031 are also reduced by A+B, because A+B (prorated taxes and rent) are funds which should legitimately be mine regardless. Ie, if the prorated April rent were one million dollars (dream big, right?) then it would reduce the sum due at closing by $1M. Would I then no longer be able to use that $1M from the exchange?

Thanks,
Allen

[Dave Foster]

@Allen B., Prorations and prepaids are generally best paid outside of closing.  But many times that is not a possibility so they get lumped into the settlement statement.  As @Tony Kim, things that don't impact your adjusted cost basis (not actual costs to purchase) will not qualify as part of your 1031.  

However, you'll probably find that your accountant can get more mileage by expensing those currently and any change in basis gets locked into the 1031.  But a current year tax expense benefits you now.

The return of earnest money should be no problem at all.  Here's an article from BP that might help - https://www.biggerpockets.com/...