Deductible and Non Deductible Selling Expenses in a 1031

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What selling expenses in a real estate transaction are not taxable if paid from the 1031 exchange proceeds? Specifically, in a 1031 exchange, what selling expenses can be paid from exchange proceeds without triggering a tax?

Deductible Selling Expenses

Selling expenses that are not taxable typically include:

Minor repairs required for the sale can be paid from exchange proceeds directly to the contractor. 

Non Deductible Selling Expenses

Selling expenses that should be taxable as ordinary income include:

• proration of rents;
• property taxes;
• property insurance premiums debited against the Exchangor;
• reserves deposited with the lender and utilities;
• any items payable in connection with a loan are considered taxable. 

Reimbursement for major repairs, capital improvements and earnest money deposits are considered taxable. The Service views the first dollar paid out as taxable. In a 1031 exchange if you need to pull these funds out, a post exchange refinance is an alternative. After the replacement property has closed, secure a line of credit on the property. You can then pull out cash without triggering a tax. 

Another alternative is to do a partial exchange, recognizing that any cash received is taxable. There is a point when the equity pulled approaches 50% that it does not make sense to initiate a 1031 exchange. Always seek the counsel of your accountant for tax planning strategies like 1031 exchanges.