--- title: Allowable Exchange Expenses and Pitfalls to Avoid with Non-Exchange Expenses description: Avoid mistakes that may impact your 1031 Exchange. image: https://blog.fgg1031.com/hubfs/Exchange%20Expenses.png --- [info@firstguardiangroup.com](mailto:) [(866)398-1031](tel:(866)398-1031) [![fgg](https://blog.fgg1031.com/hubfs/FirstGuardianGroup_2022/fgg.png)](https://brokercheck.finra.org/individual/summary/6470002) [![fgg-871923](https://blog.fgg1031.com/hubfs/FirstGuardianGroup_2023/fgg-871923.png)](https://www.bbb.org/us/ca/san-jose/profile/commercial-real-estate/first-guardian-group-1216-887513) [![logo](https://blog.fgg1031.com/hs-fs/hubfs/FirstGuardianGroup_2022/logo.png?width=175&height=56&name=logo.png "logo")](http://fgg1031.com) - [Home](https://fgg1031.com/) - [About Us](https://fgg1031.com/about-us/) - [Current Offerings](https://fgg1031.com/property-listings-directory/) - [Resource Center](https://fgg1031.com/resource-center/) - [Glossary](https://fgg1031.com/glossary/) - [Accommodators](https://fgg1031.com/accommodators/) - [FAQ](https://fgg1031.com/faqs/) - [Tax eBook](https://pages.fgg1031.com/resources/real-estate-tax-deferral-strategies-ebook) - [Real Estate eBook](https://pages.fgg1031.com/real-estate-investing-in-the-new-era2) - [QI eBook](https://pages.fgg1031.com/resources/qualifiedintermediary/ebook) - [Tax Calculator](https://fgg1031.com/tax-calculator/) - [Newsroom](https://fgg1031.com/newsroom/) - [Blog](https://blog.fgg1031.com/blog) - [Events](https://fgg1031.com/events/) - [Contact Us](https://fgg1031.com/contact/) ![search-interface-symbol](https://blog.fgg1031.com/hubfs/FirstGuardianGroup_2022/search-interface-symbol.png) ![loader](https://f.hubspotusercontent-eu1.net/hubfs/24949188/Business%20and%20Finance/global/22.gif) ![close](https://blog.fgg1031.com/hubfs/FirstGuardianGroup_2022/close.png) From Pages From Blog Pages Load More Load More **Sorry, we couldn't find a match for  "".** Check your spelling or try a related search term. [![Register](https://no-cache.hubspot.com/cta/default/5468919/d02a3ee4-7db2-4d64-b925-a6ebbfe26664.png)](https://cta-redirect.hubspot.com/cta/redirect/5468919/d02a3ee4-7db2-4d64-b925-a6ebbfe26664) ![blog-template-banner](https://blog.fgg1031.com/hs-fs/hubfs/Blog%20Banner/blog-template-banner.png?width=1920&name=blog-template-banner.png "blog-template-banner") # Blog ### Subscribe to Our Blog ### Subscribe to Email Updates ## Featured Post   [Paul Getty](https://blog.fgg1031.com/blog/author/paul-getty) ## [721 UPREIT Options in DST Programs (Part 3)](https://blog.fgg1031.com/blog/721-upreit-options-in-dst-programs) We have previously written two blog posts on 721 UPREIT options which discuss basic concepts which I encourage readers to review prior to reading this b\[...\] [Real Estate Investors](https://blog.fgg1031.com/blog/topic/real-estate-investors) [DST](https://blog.fgg1031.com/blog/topic/dst) [721 Exchange](https://blog.fgg1031.com/blog/topic/721-exchange) [UPREIT](https://blog.fgg1031.com/blog/topic/upreit) [Read More](https://blog.fgg1031.com/blog/721-upreit-options-in-dst-programs) ## Recent Posts [1031 Exchange](https://blog.fgg1031.com/blog/topic/1031-exchange) # Allowable Exchange Expenses and Pitfalls to Avoid with Non-Exchange Expenses By [Paul Getty](https://blog.fgg1031.com/blog/author/paul-getty) FGG is pleased to provide this timely guest blog previously written By [Lisa Villarreal](https://www.linkedin.com/in/lisavillarreal1/), Business Development Manager at [First American Exchange Company](https://www.firstexchange.com/). First American Exchange Company provides 1031 exchange Qualified Intermediary services nationwide and is a direct subsidiary of First American Title Insurance Company.  ##### **Avoid Mistakes That May Impact Your Exchange** The success of a taxpayer’s tax deferred 1031 exchange depends on the taxpayer’s acquired replacement property being of equal to or greater value than the property the taxpayer sold (the relinquished property). The taxpayer must invest all their exchange proceeds into the replacement property, and balance any debt paid off on the relinquished property by obtaining an equal or greater amount of financing on the replacement property (or by investing outside equity equal or greater to the relinquished property’s debt). What is often misunderstood or overlooked by taxpayers, however, is that using sales proceeds (i.e., exchange proceeds) to pay for certain expenses at the closing of the relinquished property can result in the transaction being partially taxable, even if the taxpayer “purchases up” in value. In some cases, it could even result in the taxpayer being in constructive receipt of funds, which can be fatal to a 1031 exchange’s success. ##### **Allowable Exchange Expenses\*** Certain expenses paid at closing are considered “exchange expenses” and using exchange funds to cover those costs will not result in tax liability to an exchanging party. The IRS has not been explicit on the exact costs that do and do not constitute exchange expenses. However, in Revenue Ruling 72-456, the IRS stated that it would not consider exchange funds used to pay brokers’ commissions to be taxable. Most tax advisors agree that the following expenses are considered allowable exchange expenses that may be paid at the closing of the relinquished or replacement property without any negative tax consequence:  1. *Brokers’ commissions* 2. *Exchange fees paid to a qualified intermediary* 3. *Title insurance fees for the owner’s policy of title insurance* 4. *Escrow fees* 5. *Appraisal fees for an appraisal required by the purchase contract* 6. *Transfer taxes* 7. *Recording fees* 8. *Attorney’s fees incurred in connection with the sale or purchase of the property* ##### **Non-Exchange Expenses** Other expenses are not considered exchange expenses. Exchange funds may be used to pay for some non-exchange expenses at closing without the taxpayer being in constructive receipt of funds (more on this, below), so long as they are costs that customarily appear on closing statements as the responsibility of buyer or seller. However, doing so may still result in the exchange being partially taxable. In other words, a taxpayer may have tax liability in the amount of any items paid at closing with exchange proceeds that are not considered allowable exchange expenses as outlined above. The following is a list of expenses that are typically found on a closing statement but are generally not considered exchange expenses: 1. *Loan costs and fees* 2. *Title insurance fees for lender’s title insurance policy* 3. *Appraisal and environmental investigation costs that are required by the lender* 4. *Security deposits* 5. *Prorated rents* 6. *Insurance premiums* 7. *Property taxes* Most tax advisors take the position that any fees and costs incurred in connection with obtaining a loan to acquire [replacement property](https://fgg1031.com/property-listings-directory/) are considered costs of obtaining the loan, not costs of purchasing the replacement property. Therefore, under tax law, these costs would not be considered exchange expenses. If the taxpayer uses exchange funds at the closing of the replacement property to cover loan costs and fees, it is likely that doing so will create some tax liability. To avoid this result, the taxpayer may consider depositing outside cash into the closing to pay for any loan-related expenses.  ##### **Handling Rents & Security Deposits at Closing** Security deposits and prorated rents, while commonly found on settlement statements for the sale or purchase of investment property, are not considered allowable exchange expenses. If closing funds are used to pay for these costs, the taxpayer will have tax liability on the amount of rents and security deposits paid through closing. Therefore, it is important for a seller conducting a 1031 exchange to understand how those credits will affect the seller’s exchange outcome. Since prorated rents and security deposits are not “exchange expenses,” using exchange funds to cover these costs at closing will cause the transaction to be partially taxable. Providing the buyer a credit is equivalent to using sales proceeds, i.e. exchange funds, to pay the buyer an amount equal to the credit. As a result, fewer proceeds from the sale are available to the seller at closing to utilize toward the purchase of their replacement property.  For example, if a taxpayer sells property for $5 million and owes the buyer $100,000 in prorated rents and security deposits, the taxpayer will typically provide the buyer a credit for $100,000, resulting in the buyer effectively paying the seller $4.9 million instead of $5 million (this example ignores other costs likely to be involved). The closing agent would send $4.9 million to First American Exchange Company as Qualified Intermediary as exchange proceeds, which would be used to acquire the taxpayer’s identified replacement property. Since the total potential sales proceeds / exchange funds from the relinquished property sale were $5 million, but only $4.9 million would be available to acquire the replacement property, the transaction would be taxable up to the $100,000 that was used to pay the buyer credit (even if all other proceeds are reinvested in replacement property). A work-around is for a seller to come up with their own funds to pay these non-exchange expenses directly to the buyer. The costs can be handled outside of closing, or the seller can bring the funds into the closing to cover these amounts, resulting in the full amount of exchange proceeds being wired to the exchange account at closing. These strategies can be used to avoid having a taxable consequence for any non-exchange expense, whether prorated security deposits or rentals, or credits to be given to the buyer for prorated property taxes. ##### **Transactional Items and Constructive Receipt** A separate, but important, issue is whether paying certain expenses at closing will show that the taxpayer has constructive receipt of their exchange funds, which could potentially render the entire exchange invalid. Exchange funds may be used to purchase the replacement property, including making deposits, and to pay for typical costs related to the sale or purchase of relinquished or replacement property, such as prorated rents and broker commissions. As a general rule, as briefly discussed above, exchange funds can be used to pay for “transactional items that relate to the disposition of the relinquished property or to the acquisition of the replacement property and appear under local standards in the typical closing statement as the responsibility of a buyer or seller (e.g., commissions, prorated taxes, recording or transfer taxes, and title company fees).”  Because of the wording of the regulations, costs that are not typically paid on a closing statement in the area where the property is located, and costs that are unrelated to the sale or purchase, may trigger a constructive receipt issue if exchange funds are used to cover them. In addition, because of the wording of this rule, many tax advisors caution against paying expenses with exchange funds in between the closing of the relinquished and replacement properties.  One common situation where this issue arises is when an investor wants to use exchange funds to pay rate lock-in fees to a lender. Since these fees by their nature are paid before the closing to lock in an interest rate, they do not “appear under local standards in the typical closing statement,” and therefore may trigger a constructive receipt issue. Similarly, it can be tempting for a seller to include certain credits to the buyer for repairs or improvement costs made to a relinquished property, or to include other items such as payoffs of loans or debts that are not secured by or related to the relinquished property, on the closing statement. Since there is no clear IRS interpretation of this rule, investors need to discuss the issue with their tax advisors before paying unrelated expenses at a closing, or any expenses in between closings.  It is advisable to always have your tax advisor review the numbers on your closing statement(s) prior to closing. That will ensure that you have a good sense of the net proceeds you will be working with when acquiring replacement property, and whether you will have a fully tax-deferred exchange or have any taxable expenses to take into account. \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ For more information on 1031 Exchange tax deferral strategies, please contact First Guardian Group at 866 398-1031 or [info@FirstGuardianGroup.com](mailto:info@FirstGuardianGroup.com). --- ##### **Help Save 1031 Exchanges** Write to your Member of Congress and Senators urging them to oppose restricting Section 1031 like-kind exchanges. As part of the American Families Plan, the Biden Administration has proposed eliminating the application of Section 1031 for gains greater than $500,000. Like-kind exchanges have been part of the U.S. tax code since 1921 and are one of the tax code’s most powerful economic tools. It is critical that we all vigorously and visibly oppose this proposal. Make your voice heard with a pre-filled letter, which you can customize to add personal anecdotes or powerful client stories to highlight the positive impact of Section 1031 like-kind exchanges. Take action today by clicking [HERE](https://p2a.co/XLBiUYT)[**.**](https://p2a.co/XLBiUYT) --- **[![New call-to-action](https://no-cache.hubspot.com/cta/default/5468919/60c88fab-3361-40dd-9cab-769d1eb620de.png)](https://cta-redirect.hubspot.com/cta/redirect/5468919/60c88fab-3361-40dd-9cab-769d1eb620de)** \*References: Revenue Ruling 72-456; Treasury Regulation Section 1.1031(k)-1(g)(6) and (7); IRS Form 8824.  ### [Paul Getty](https://blog.fgg1031.com/blog/author/paul-getty) Paul M. Getty is one of the most experienced 1031 exchange specialists in the United States, with a career in real estate that spans over 35 years and more than $5 billion in commercial transactions across every major asset class. His work covers single-family rentals, apartments, retail, office, multifamily, and student and senior housing, giving him a practical understanding of how different property types perform across market cycles and how investors can move between them using tax-deferred exchange strategies. As President and CEO of FGG1031 | First Guardian Group, Paul advises investors through the full 1031 exchange process, from identifying qualifying replacement properties to structuring acquisitions through Delaware Statutory Trusts (DSTs) and wholly owned real estate. His guidance covers both the compliance requirements of a valid exchange and the investment decisions that determine long-term portfolio outcomes – a combination that is difficult to find in a single advisor. Paul holds a California and Texas real estate broker license and carries Series 22, 62, 63, and 82 securities licenses as a registered representative with Emerson Equity LLC, member FINRA /SIPC. He has represented buyers and sellers across complex commercial transactions, sourced and structured debt and equity, and worked alongside nationally recognized firms including Marcus Millichap, CBRE, JP Morgan, and Morgan Stanley. Before founding FGG1031, he co-founded Venture Navigation, a boutique investment banking firm whose M&A and IPO activity generated over $700 million in investor returns. Paul holds an MBA in Finance from the University of Michigan and a bachelor’s degree in chemistry from Wayne State University. He has also completed coursework in artificial intelligence at Stanford University. He is the author of four books on real estate investing and tax deferral strategy, including Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST) and Real Estate Investing in the New Era, both available on Amazon. A frequent speaker on 1031 exchanges, DST investing, and real estate tax strategy, Paul Getty is a recognized voice for investors and advisors seeking guidance on capital preservation through tax-deferred real estate investment. ## Your Comments : This is a search field with an auto-suggest feature attached. - There are no suggestions because the search field is empty. - Latest Posts - Popular Posts [Partial 1031 Exchange: How It Works, What Gets Taxed, and When It May Make Sense](https://blog.fgg1031.com/blog/partial-1031-exchange-how-it-works) [ 1031 Exchange](https://blog.fgg1031.com/blog/topic/1031-exchange) [721 UPREIT Options in DST Programs (Part 3)](https://blog.fgg1031.com/blog/721-upreit-options-in-dst-programs) [ Real Estate Investors](https://blog.fgg1031.com/blog/topic/real-estate-investors) [ DST](https://blog.fgg1031.com/blog/topic/dst) [ 721 Exchange](https://blog.fgg1031.com/blog/topic/721-exchange) [ UPREIT](https://blog.fgg1031.com/blog/topic/upreit) [ New featured](https://blog.fgg1031.com/blog/topic/new-featured) [Can a 9% Taxable Return Beat a 4.5% Tax Advantaged DST?](https://blog.fgg1031.com/blog/can-a-9-taxable-return-beat-a-4.5-tax-advantaged-dst) [ Real Estate Investors](https://blog.fgg1031.com/blog/topic/real-estate-investors) [ DST](https://blog.fgg1031.com/blog/topic/dst) [ New featured](https://blog.fgg1031.com/blog/topic/new-featured) ### Categories - 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[Investing in Senior Housing October 20, 2022](https://blog.fgg1031.com/blog/investing-in-senior-housing) - [A Closer Look at the 7 Deadly Sins October 20, 2022](https://blog.fgg1031.com/blog/a-closer-look-at-the-seven-deadly-sins) - [What is a Springing LLC? October 20, 2022](https://blog.fgg1031.com/blog/what-is-a-springing-llc) ## Useful Links - Home - About Us - Blogs - Testimonials from Past Customers - Resource Center - Current Offerings Disclaimer: There is no guarantee that any strategy will be successful or achieve investment objectives. All real estate investments have the potential to lose value during the life of the investments. This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please be aware that this material cannot and does not replace the Memorandum and is qualified in its entirety by the Memorandum. This material is not intended as tax or legal advice so please do speak with your attorney and CPA prior to considering an investment. This material contains information that has been obtained from sources believed to be reliable. However, FGG1031, First Guardian Group, LightPath Capital, Inc., and their representatives do not guarantee the accuracy and validity of the information herein. Investors should perform their own investigations before considering any investment. There are material risks associated with investing in real estate, Delaware Statutory Trust (DST) and 1031 Exchange properties. These include, but are not limited to, tenant vacancies, declining market values, potential loss of entire investment principal. Past performance is not a guarantee of future results: potential cash flow, potential returns, and potential appreciation are not guaranteed in any way and adverse tax consequences can take effect.  The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All financed real estate investments have a potential for foreclosure. Delaware Statutory Trust (DST) investments are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits. IRC Section 1031, IRC Section 1033, and IRC Section 721 are complex tax codes; therefore, you should consult your tax and legal professional for details regarding your situation. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over one million dollars exclusive of primary residence) and accredited entities only (generally described as an entity owned entirely by accredited individuals and/or an entity with gross assets of greater than five million dollars). If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney prior to considering an investment. Securities offered through registered representatives of [LightPath Capital, Inc.](http://www.lightpathcapital.com/) Member [FINRA](http://www.finra.org/) / [SIPC](https://www.sipc.org/). FGG1031, First Guardian Group, and LightPath Capital, Inc. are separate entities. Copyright 2022, All Rights Reserved, FGG1031 [![FGG_Footer_White](https://blog.fgg1031.com/hs-fs/hubfs/FirstGuardianGroup_2022/FGG_Footer_White.png?width=300&height=95&name=FGG_Footer_White.png "FGG_Footer_White")](http://fgg1031.com) 97 East Brokaw Road, Suite 350, San Jose, CA 95112 [(866) 398 1031](tel:(866)%20398%201031) [info@firstguardiangroup.com](mailto:) [![Bitmap](https://blog.fgg1031.com/hubfs/FirstGuardianGroup_2023/Bitmap.png)](https://brokercheck.finra.org/individual/summary/6470002) ## Recent Blogs - [Understanding the Difference Between Inheritance and Estate Tax August 3, 2023](https://blog.fgg1031.com/blog/understanding-the-difference-between-inheritance-and-estate-tax) - [Public or Private Real Estate? Your Investment Portfolio May Need Both July 27, 2023](https://blog.fgg1031.com/blog/public-or-private-real-estate-your-investment-portfolio-may-need-both) - [How to Use 1031 Exchange Funds to Improve Your Replacement Property July 20, 2023](https://blog.fgg1031.com/blog/how-to-use-1031-exchange-finds-to-improve-your-replacement-property) ## Useful Links - [Home](http://fgg1031.com/) - [About Us](https://fgg1031.com/about-us/) - [Blogs](https://blog.fgg1031.com/blog) - Testimonials from Past Customers - [Resource Center](https://fgg1031.com/resource-center/) - [Current Offerings](https://fgg1031.com/property-listings-directory/) FGG1031 | First Guardian Group and Emerson Equity LLC do not provide legal or tax advice. Securities offered through [Emerson Equity LLC](http://www.emersonequity.com/) Member [FINRA/SIPC](http://finra.org/) and MSRB registered. Emerson Equity LLC is unaffiliated with any entity herein. 1031 Risk Disclosure: - There is no guarantee that any strategy will be successful or achieve investment objectives; - Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments; - Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities; - Potential for foreclosure – All financed real estate investments have potential for foreclosure; ·Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments; - Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions; - Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits No offer to buy or sell securities is being made. Such offers may only be made to qualified accredited investors via private placement memorandum. Risks detailed in a private placement memorandum should be carefully reviewed, understood and considered before making such an investment. Prospective strategies and products used in any tax advantaged investment planning should be reviewed independently with your tax and legal advisors. Changes to the tax code and other regulatory revisions could have a negative impact upon strategies developed and recommendations made. Past performance and/or forward looking statements are never an assurance of future results. Many of the investments offered will be only available to those investors meeting the definition of an Accredited Investor under SEC Rule 501(A) and offered as Regulation D private placement securities via a Private Placement Memorandum (“PPM”). Prospective investors must receive, read and understand all of the risks associated with buying private placement securities. Investments are not guaranteed or [FDIC](http://fdic.org/) insured and risks may include but are not limited to illiquidity, no guarantee of income or guarantee that all tax advantages or objectives will be met and complete loss of principal investment could occur. **Risk Disclosure:** Alternative investment products, including real estate investments, notes & debentures, hedge funds and private equity, involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor's interest in alternative investments, and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-U.S. exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in U.S. markets. Additionally, alternative investments often entail commodity trading, which involves substantial risk of loss. NO OFFER OR SOLICITATION: The contents of this website: (i) do not constitute an offer of securities or a solicitation of an offer to buy of securities, and (ii) may not be relied upon in making an investment decision related to any investment offering by FGG1031 | First Guardian Group, Emerson Equity LLC, or any affiliate, or partner thereof. FGG1031 | First Guardian Group does not warrant the accuracy or completeness of the information contained herein. Copyright 2026, All Rights Reserved, FGG1031