The general rule when it comes to 1031 exchanges is that all proceeds from the sale must be reinvested in the replacement property, but as a property investor you likely have experience with the other costs associated with closing on a sale, including your real estate agent's commission, the recording of the deed, and know that some of your proceeds must be put towards these sorts of transactional expenses.
These sorts of expenses don't seem to fit on your typical closing statement, and for good reason. Some costs are appropriate to debit off your closing statement during a 1031 exchange transaction, and there are some that most certainly are not.
The proper way to deal with these situations is to write a check covering the remaining rent and security deposit to the purchaser, taking the money out of your operating account. Some investors, however have tried to debit these kinds of expenses to the closing statement. This is inappropriate and subverts the premise of section 1031 of U.S. tax code.
In the process of a 1031 exchange, you will also face expenses related to the acquisition of new debt on your replacement property. Loan origination fees, underwriting fees, and processing fees are not part of a like-kind exchange and the money must come out of your own property.
In the real estate business, it is always advisable to take care when dealing with the variety of expenses that arise during a closing, and this is doubly important when making 1031 transactions. Section 1031 is based on the idea of a like-kind exchange, in which you move everything from point A to point B without skimming any kind of cash benefits or proceeds off the top, so it is best to avoid debiting expenses in a way that usurps this premise.
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United States investors can save big money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is almost like getting an interest free loan from Uncle Sam!
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