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. 

Any proceeds or cash benefits you receive from a 1031 transaction are known as boot. Boot is not part of a like-kind exchange, and is therefore considered taxable.Closing on a sale will always carry associated costs such as agents' commissions and deed recording fees.  It is acceptable to debit these off on your closing statement, because they do not represent any extra cash benefits for you.  Expenses such as prorated rent and security deposits that must be transferred to the new owner are another story.

The correct way to go about transferring future rent and security deposits to the new owner of the property is to cut a check from your own expense account.  If you debit these kinds of expenses to your closings statement, you are effectively freeing money in your account for your own use and taking what as known as boot from the proceeds of the transaction.  Any cash benefit or boot you receive from the sale is not considered part of a like-kind exchange, and investors who have attempted this have found themselves facing IRS litigation.

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.

The fact of the matter is that the IRS examines these sorts of transactions, and will not look kindly on your receiving non-like-kind proceeds or cash benefits from 1031 transactions.  With this in mind, you should be wary and take care regarding what expenses end up on your closing statement.

U.S. investors can save their money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. 1031 tax exchange is like an interest free loan from Uncle Sam!