Property Tax and Mortgage Interest paid from escrow in 1031 exchange

[Karen Leonard]

I am in contract to sell an investment property, and the proceeds will go to the 1031 QI that I've identified. The preliminary Seller's Settlement statement plans to pay the prorated property tax, and mortgage interest, up to the day of closing out of the proceeds - as expected and done in a normal sale. If I'm reading 1031 exchange rules correctly, neither of those costs are permissible selling expenses or closing costs.

I offered to pay the prorated property tax directly to the county (the exact amount calculated in escrow), but the escrow agent said property tax must either be paid in full (and prorated amount credited back to seller), or unpaid (and prorated amount pulled out of the proceeds). Both the escrow agent and the QI said that if I got the prorated property tax back (in the scenario where I prepaid out of escrow), it would be considered boot, and taxes withheld (3.33% in California). They haven't agreed that this is an eligible reimbursable expense ("any funds that go to the seller are boot", they say).

Paying the mortgage interest outside of escrow also doesn't seem straightforward. My bank only has "principal payment" and "principal and interest" payment choices, when choosing to pay outside of the normal autopay I have set up. i.e. there's no "interest only" payment option.

How are these expenses to be paid, logistically, outside of escrow? Or, am I misunderstanding how to treat these debts in a 1031 exchange?

[Karen Leonard]

Thank you, @Dave Foster (and @Alex Olson for tagging him!). Your response and the linked article were the clarity I needed. 

I've worked out a solution with my escrow officer that keeps these out of "boot" territory - I will bring cash to closing that will pay the prorated property taxes, and this month's mortgage interest (to the closing date). My net proceeds will then be my sale price, less true eligible expenses.

I love BP's knowledgeable community and informative articles!