1031 Exchange Closing Costs: What Exchange Funds Can Pay

The Core Rule: Acquisition Costs vs. Personal Costs

The key principle for whether a cost can be paid from exchange funds without creating boot:

Acquisition Costs (Generally OK): Costs necessary to acquire and title the replacement property. These include title insurance, recording fees, escrow fees, survey (if required for acquisition).

Personal/Financing Costs (Generally NOT OK): Costs that are lender-related, repair-related, or personal expenses. These include loan origination fees, points, lender-required reserves, repairs, inspections, appraisals.

When you pay a personal cost from exchange funds, you're using exchange proceeds on something other than the replacement property itself. This reduces the amount available for the property and can create boot.

Let's break down the major cost categories.

Settlement and Acquisition Costs: Generally OK

These are costs directly associated with acquiring your replacement property and can typically be paid from exchange proceeds without creating boot.

Title Insurance

Cost: $1,000-$3,000 depending on property value and location

Can exchange pay? Yes, generally.

Why: Title insurance is a cost of acquiring the property. It protects your ownership interest. Most QIs and CPAs approve paying title insurance from exchange funds.

Consideration: Some title insurance costs are lender-required reserves (e.g., your lender requires a title policy and escrow holdback). These might be classified as lender costs rather than acquisition costs. Clarify with your title company.

Recording and Transfer Fees

Cost: $100-$500 depending on jurisdiction and property value

Can exchange pay? Yes.

Why: Recording fees are costs of formalizing your acquisition. They're necessary and directly attributable to acquiring the property.

Escrow Fees

Cost: $500-$2,000 depending on property value and escrow company

Can exchange pay? Yes, generally.

Why: Escrow fees are the cost of the escrow holding and closing process. They're directly related to the acquisition.

Consideration: If your escrow company is billing multiple services (escrow, coordination, wire fees), clarify which services are acquisition-related and which are optional.

Survey and Property Boundary Work

Cost: $300-$1,500 depending on property size and complexity

Can exchange pay? Generally yes, if required for acquisition.

Why: If the lender requires a survey or you need boundary verification to complete the acquisition, it's an acquisition cost.

Consideration: If the survey is optional or for your own information, it might be considered personal. Clarify with your QI.

1031 Qualified Intermediary Fees

Cost: $500-$2,000 depending on exchange complexity

Can exchange pay? Yes, this is standard.

Why: QI fees are the cost of the exchange mechanism itself. These are paid from exchange proceeds and reduce the amount available for the property, but this is normal and expected. It's built into your boot calculation.

Lender Costs: Generally NOT OK (or Create Boot)

These costs are related to your financing rather than the property acquisition itself. Paying them from exchange funds reduces the property acquisition amount and may create boot.

Loan Origination Fees

Cost: 0.5% to 1.5% of loan amount (so $2,500 to $7,500 on a $500,000 loan)

Can exchange pay? Technically yes, but not recommended.

Why it's problematic: An origination fee is a lender cost. If you pay it from exchange funds, you're using exchange proceeds on a financing cost, not on the property itself. This reduces your replacement property value and can trigger boot.

Example:

• Exchange proceeds: $300,000
• Lender origination fee: $3,000
• If paid from exchange funds: only $297,000 available for property
• Property purchased: $300,000 (on your purchase agreement)
• Shortfall: $3,000 (potential boot or unfunded acquisition)

Better: Pay the origination fee from personal funds or obtain a no-cost or lender-paid loan (lender pays the origination fee).

Loan Discount Points

Cost: 1-3 points = 1-3% of loan amount ($5,000 to $15,000 on a $500,000 loan)

Can exchange pay? Technically yes, but not recommended for same reason as origination fees.

Why it's problematic: Points are optional financing costs you're paying to reduce your interest rate. They're not necessary for the acquisition. Paying them from exchange funds reduces property acquisition funds and may create boot.

Better: Pay points from personal funds if you want to buy down the rate, or accept a higher rate to avoid the cost.

Lender-Required Reserves and Escrow Holdbacks

Cost: Variable, typically 3-6 months of taxes/insurance = $2,000-$10,000

Can exchange pay? Generally not recommended without clarity.

Why it's problematic: Your lender might require an escrow account funded with 3-6 months of property taxes and insurance at closing. This is a reserve held by the lender.

If you pay this from exchange funds, you're using proceeds on a financing requirement rather than property value. It reduces the funds available for the property.

Better: Confirm whether this is required or optional. If optional, pay from personal funds. If required, work with your CPA and QI to properly characterize it.

Loan Assumption Fees

Cost: $500-$2,000 depending on lender

Can exchange pay? Generally not.

Why: An assumption fee is a financing cost, not an acquisition cost. It's better paid from personal funds.

Repair and Improvement Costs: Timing Matters

Whether repairs can be paid from exchange funds depends on timing and whether they're capitalized improvements or ordinary repairs.

Pre-Closing Repairs (Seller Responsibility)

Cost: Variable

Can exchange pay? Generally no, not at closing.

Why: Pre-closing repairs are typically the seller's responsibility. If the property is being sold "as-is," it's your responsibility as buyer to decide whether to accept condition and negotiate price.

If you want the seller to do repairs, negotiate it in the purchase agreement before closing. Don't plan on funding repairs through the 1031 exchange at closing.

Better approach: Buy the property as-is at the agreed price, accept the condition, and use your own funds or separate financing for repairs if desired.

Post-Closing Repairs and Improvements (Using Exchange Funds)

If you want exchange funds to pay for improvements after acquisition, you need a different structure: a build-to-suit or improvement exchange.

In this structure, your QI holds funds and pays contractors post-closing. This requires more QI involvement and typically a 120-180 day construction timeline.

See our guide on improvement exchanges for details.

Seller Concessions for Repairs

Some purchase agreements include seller concessions for repairs (seller agrees to pay $X toward repairs as a credit to buyer at closing).

This affects your net purchase price but is handled through the purchase agreement, not through the 1031 exchange mechanism.

Real Estate Agent Commissions: Generally NOT OK

Seller-Side Commission (Your Side)

Cost: Typically 2.5-3% of sale price ($6,000-$15,000 on a $500,000 sale)

Where does it come from? Your sale proceeds, not your exchange proceeds.

On the sale side: Commission reduces your net proceeds from the sale. It comes out before your QI receives funds.

On the purchase side: You're typically the buyer, not paying commission. The buyer doesn't pay commission in most real estate transactions.

Buyer-Side Commission (Unusual)

In some transactions, the buyer pays commission (rare, usually only in commercial or investment property with buyer's agents).

Can exchange pay? Generally not at closing without careful characterization.

Better: Negotiate whether you're paying buyer commission and settle it outside of the exchange mechanism.

Legal and Accounting Costs: Partially OK

Qualified Intermediary Legal Fees

Cost: $500-$1,500

Can exchange pay? Yes, typically.

Why: QI legal fees are part of setting up and administering the exchange. These are often included in the total QI costs.

Exchange Legal Consultation (Your Attorney Reviewing the Exchange)

Cost: $500-$2,000 depending on complexity

Can exchange pay? This is a gray area.

Why it's gray: Legal fees for reviewing the exchange structure are arguably related to the exchange mechanism. Some QIs allow these to be paid from exchange funds, others don't.

Better: Clarify with your QI upfront. Some exchanges are structured to pay your exchange attorney from exchange proceeds; others expect you to pay personally.

General Tax Preparation or Tax Planning

Cost: $1,000-$3,000

Can exchange pay? No.

Why: General tax preparation is personal and not acquisition-related. It can't be paid from exchange funds.

Better: Pay your tax advisor from personal funds.

Real Estate Taxes and Prorations: Complex

Property taxes, insurance, HOA fees, and other prorations at closing are handled through seller/buyer credits and prorations, not directly from exchange funds.

However, there's a potential boot trap here.

How Prorations Work

At closing, taxes are divided based on the closing date. If the seller has paid taxes for the year but you're taking ownership mid-year, the seller gets a credit and you owe the remaining portion.

This is handled as a dollar adjustment at closing (seller credit or buyer debit).

The Boot Trap

If your QI doesn't carefully structure the prorations, they could be characterized as reducing your replacement property value.

Example:

• Purchase price: $300,000
• Prorated property tax owed by buyer: $2,000 (your responsibility for the remainder of the year)
• If your QI pays the $2,000 from exchange funds and it reduces the funds available for the property, you've created $2,000 in potential boot

Prevention: Clarify with your QI and closing attorney how prorations will be handled. Ideally, prorations are settled through the escrow process (seller credits applied, you owe the net), and they don't reduce your exchange funds.

What to Tell Your Escrow Officer: Instruction Checklist

Before closing, provide your escrow officer with clear instructions about which costs to pay from 1031 exchange funds.

Here's a sample instruction you can adapt:

"I'm conducting a 1031 exchange. My qualified intermediary is [QI Name and Contact]. Please confirm all instructions with them.

Exchange funds should be used ONLY for:

• Replacement property purchase price
• Title insurance for the replacement property
• Recording and transfer fees
• Escrow closing fee (our share as buyer)
• Qualified intermediary fees (payable to [QI Name])

The following costs should NOT be paid from exchange funds:

• Loan origination fees and points (we will pay personally or obtain a lender-paid loan)
• Lender escrow reserves (we will pay personally or the lender will pay at closing)
• Inspection, appraisal, survey (if not required by lender, we will pay personally)
• Any repairs or improvements
• Our attorney's fees (we will pay personally)

Prorations for property taxes, insurance, and HOA should be settled through standard escrow procedures. If I owe money on prorations, this is my personal responsibility, not paid from exchange funds.

Before disbursing any funds, please confirm with my QI that all allocations are correct and no boot has been created."

Common Closing Cost Mistakes

Mistake 1: Paying Lender Fees from Exchange Funds Without Realizing Boot Impact

You close on your replacement property. Your lender charges $3,000 origination fee. Your escrow officer pays it from exchange funds without flagging the issue.

Later, your CPA discovers you had $300,000 in exchange proceeds, paid $3,000 in lender fees from those proceeds, leaving $297,000 for property acquisition. But you negotiated a $300,000 property purchase. You had $3,000 in unclaimed boot.

You owed capital gains tax on $3,000 of gain. You didn't pay it.

Prevention: Review all closing costs upfront with your CPA and QI. Know which ones will be paid from exchange funds and which from personal funds.

Mistake 2: Prorations Reducing Exchange Funds Without Clarity

Your replacement property purchase includes $2,500 in prorated property taxes that you owe (seller credit to cover their half of the year).

Your escrow officer deducts $2,500 from the exchange funds disbursement to cover the proration you owe.

Your CPA later questions whether the $2,500 should have been boot.

Prevention: Confirm with your escrow officer and QI how prorations will be handled before closing. Ensure they're not reducing the funds available for the property.

Mistake 3: Paying Points to Buy Down the Interest Rate from Exchange Funds

You decide to pay 2 points ($5,000) to reduce your interest rate by 0.5%. You pay from exchange funds thinking it's an acquisition cost.

Your CPA says this should have been paid from personal funds, not exchange funds. It creates boot or reduces your property value.

Prevention: Discuss all financing decisions (points, origination fees, rate buydowns) with your QI and CPA before closing. Decide upfront whether to pay from exchange or personal funds.

Summary: Use This Framework

CAN be paid from exchange funds (acquisition-related):

• Replacement property purchase price
• Title insurance
• Recording and transfer fees
• Escrow closing fees
• QI fees
• Survey (if required for acquisition)

SHOULD NOT be paid from exchange funds (financing or personal costs):

• Loan origination fees
• Discount points
• Lender escrow reserves
• Repairs and improvements (unless structured as improvement exchange)
• Inspections and appraisals (personal costs)
• Your attorney fees for general advice
• Real estate commissions on your purchase side

GRAY AREA (clarify with QI and CPA):

• Prorations and property tax adjustments
• Lender-required title policies and escrow
• Your attorney fees specific to the exchange
• Seller concessions for repairs

Before closing, sit down with your qualified intermediary and CPA. Walk through the anticipated closing statement line-by-line.

Agree on which costs will be paid from exchange funds and which from personal funds. Get it in writing. This prevents boot surprises and ensures your 1031 exchange is properly structured.