Taxpayers are encouraged to bring cash to the closing of the sale of their property to pay for the following: Non-transaction costs: i.e. Rent prorations, Utility escrow charges, Tenant damage deposits transferred to the buyer, and any other charges unrelated to the closing.
* Excess borrowing to acquire replacement property. Borrowing more money than is necessary to close on replacement property will not result in the taxpayer receiving tax-free money from the closing. The funds from the loan will be the first to be applied toward the purchase. If the addition of exchange funds creates a surplus at the closing, all unused exchange funds will be returned to the Qualified Intermediary, presumably to be used to acquire more replacement property. Loan acquisition costs (origination fees and other fees related to acquiring the loan) with respect to the replacement property should be brought to the closing from the taxpayer's personal funds. Taxpayers usually take the position that loan acquisition costs are being paid out of the proceeds of the loan. However, the IRS may take the position that these costs are being paid with Exchange Funds. This position is usually the position of the financing institution also. Unfortunately, at the present time there is no guidance from the IRS on this issue which is helpful.
* Non-like-kind property which is received from the exchange, in addition to like-kind property (real estate).
Non-like-kind property could include the following:
- Seller financing, promissory note.
- Sprinkler equipment acquired with farm land.
- Ditch stock in a mutual irrigation ditch company acquired with farm land (possible issue).
- Big T Water acquired with farm land (possible issue).
Acquisition of ditch stock or Big T water is a possible issue with the IRS. In reporting their exchanges of farm land most taxpayers take the position that water on the farm land is like kind to the land. The IRS has been known to have a different view.
Boot Offset Rules :
Only the net boot received by the taxpayer is taxed. In determining the amount of net boot received by the taxpayer, certain boot off-set rules come into play. They are as follows:
- Cash boot paid (replacement property) always offsets cash boot received (relinquished property).
- Debt boot paid (replacement property) always offsets debt-reduction boot received (relinquished property).
- Cash boot paid always offsets debt-reduction boot received. Debt boot paid never offsets cash boot received (net cash boot received is always taxable).
- Qualified costs paid (between both the relinquished and replacement property closings) always offset net cash boot received .
Boot tips:
- Always trade "Across" or up. Never trade down. Trading down always results in boot received, either as cash, debt reduction or both. The boot received can be off-set by qualified costs paid by the Exchanger.
- Bring cash to the closing of the replacement property to cover loan fees or other charges which are not qualified costs. (See above)
- Do not receive property which is not like-kind.
- Do not over-finance replacement property. Financing should be limited to the amount of money necessary to close on the replacement property in addition to exchange funds which will be brought to the replacement property closing.
