1031 Exchange Closing Costs: What Exchange Funds Can Pay

Not every closing cost can be paid from exchange funds without creating boot. The core test is simple: is the cost an acquisition expense necessary to title the replacement property, or is it a personal or financing expense? Acquisition expenses are generally safe. Personal and financing expenses reduce the funds applied to the property and may trigger taxable boot.

The reference table below sorts the most common line items. After the table, an annotated settlement-statement walkthrough shows how these rules work in practice.

Closing-cost classification table

The core test

Ask one question about every line item: Does this cost go toward acquiring and titling the replacement property, or does it serve a personal, financing, or elective purpose?

• If it acquires or titles the property, it can generally be paid from exchange funds.
• If it is a lender requirement, a personal expense, or an elective service, pay it from personal funds.

When in doubt, pay from personal funds. Overpaying from personal funds never creates boot. Paying a non-qualifying cost from exchange funds can.

Annotated settlement-statement example

Below is a simplified buy-side settlement statement for a $500,000 replacement property purchase. The "Source" column shows the correct funding source for each line.

In this example, the investor's exchange funds cover the purchase price plus qualifying acquisition costs. All financing and personal costs come out of pocket, preserving the full replacement-property value for 1031 purposes.

If the investor had instead paid line items 6-11 from exchange funds, the effective replacement-property value credited to the exchange would drop by $12,600, potentially creating boot.

Escrow-officer instruction checklist

Before closing, provide your escrow officer with clear written instructions. A sample you can adapt:

"I am conducting a 1031 exchange. My qualified intermediary is [QI Name, contact info]. Please confirm all disbursement instructions with them.

Pay from exchange funds only:

• Replacement property purchase price
• Owner's title insurance
• Recording and transfer fees
• Escrow / settlement closing fee
• QI fees (payable to [QI Name])

Do NOT pay from exchange funds:

• Loan origination fees and points (I will pay personally or obtain a lender-paid structure)
• Lender escrow reserves (I will pay personally)
• Inspection, appraisal, survey (unless QI confirms acquisition-related)
• Repairs or improvements
• My attorney's fees

Prorations for property taxes, insurance, and HOA should be settled through standard escrow procedures. Any amounts I owe on prorations are my personal responsibility and should not reduce exchange funds.

Before disbursing any funds, please confirm with my QI that all allocations are correct."

Common mistakes

Paying lender fees from exchange funds without realizing the boot impact. The escrow officer pays a $3,000 origination fee from exchange proceeds. Later, the CPA discovers only $297,000 of the $300,000 in proceeds went to acquisition value. The $3,000 shortfall is boot.

Prorations reducing exchange funds without clarity. A $2,500 property-tax proration is deducted from exchange proceeds. Whether this creates boot depends on how it is characterized. Confirm the treatment with your QI and CPA before closing, not after.

Paying discount points from exchange funds. An investor pays two points ($5,000) from exchange proceeds to buy down the interest rate. This is a financing cost, not an acquisition cost. It reduces the replacement-property value credited to the exchange.

Prevention for all three: Before closing, sit down with your qualified intermediary and CPA. Walk through the anticipated settlement statement line by line. Agree in writing on which costs come from exchange funds and which come from personal funds.