Closing Costs and  the Tax Deferred  Exchange    

Revenue ruling 72-456 ruled that brokerage commissions paid in a section 1031 exchange are to be treated as property boot given.  Therefore, these commissions may be offset against mortgage or property boot received.  The advantage is that otherwise taxable net boot received by the exchanger may be reduced by the transaction costs including brokerage commissions. 

The ruling only addressed commissions but may also be applied to all other non-deductible transaction costs.  Mercantile Trust Company v. Commissioner 32 B.T.A. 82 (1935), provides the needed authority for the netting of property boot against other transaction costs.  Please note that deductible item such as taxes, interest, commitment fees for loans, and prepayment penalties do not constitute transaction costs under the rule.  Thus if the exchanger uses a portion of his exchange equity to pay such normally prorated items, he is treated as having received property boot (cash) to the extent he does not reinvest all of his exchange equity in the acquired property and will be taxed on this portion.  However. a section 266 election may be made to capitalize normally deductible items such as interest, and other expenses and allow the expenses to be netted against cash (property boot) received.  This allows an exchanger to actually trade down, by the amount of the transaction costs, to a less expensive property. 

Revenue ruling 72-456 not only allowed the exchanger to offset real estate commissions against net boot received but also stated that the commissions are to be added tot he basis of the acquired property.  Thus the ruling allows the exchanger to both offset boot and increase basis and then the amount of realized gain carried over into the acquired property will be less than the gain deferred under the exchange.  Therefore, there should be no more complaints about the broker's commissions until the IRS corrects the oversight.

For more information on this matter or if we may be of further assistance please contact us for a free consultation by calling us at 1 (800) 781-1031 or (714) 939-1031 or by e-mail at info@cornerstoneexchange.com