Recording a 1031 exchange takes two main journal entries: one to remove the relinquished property and park the sale proceeds with a qualified intermediary while booking the deferred gain as a liability, and a second to bring the replacement property onto the balance sheet and clear the intermediary account. If boot changes hands, a small reclassification entry moves part of the deferred gain into recognized gain. The logic is a swap of one asset for another with the unrealized gain preserved for later taxation, and the entries have to reflect that.
Two Numbers You Need Before Booking Anything
Every entry below flows from two figures: the adjusted basis of the property you are giving up and the deferred gain on the sale.
Adjusted basis is the property’s cost for tax purposes. Start with what you paid, add capital improvements, and subtract all depreciation claimed during the holding period.1Internal Revenue Service. Topic No. 703, Basis of Assets
The deferred gain is net sale proceeds (sale price minus selling expenses) minus that adjusted basis. In a fully qualifying exchange with no cash or non-like-kind property coming back to you, the whole gain defers rather than being recognized.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment That deferred gain lives on the balance sheet as a liability until the replacement property is sold in a taxable transaction.
Entry to Remove the Relinquished Property
The first entry touches four accounts: the original asset, its accumulated depreciation, a temporary asset for the funds held by the qualified intermediary, and a deferred gain liability.
The intermediary matters here for a reason that shapes the entry. A qualified intermediary is an independent third party holding the sale proceeds during the exchange period. If you touch the money yourself, the IRS treats you as having received it and the exchange fails.3Internal Revenue Service. Fact Sheet FS-2008-18 – Like-Kind Exchanges Under IRC Section 1031 Treasury regulations require that the intermediary not already work for you (your attorney, accountant, or real estate agent will not qualify), and the exchange agreement must expressly restrict your ability to access the funds before closing.4GovInfo. Treasury Regulation 1.1031(k)-1 That is why the cash line goes into a separate “Held by QI” account rather than to your operating cash.
Assume an example throughout: a property with an original cost of $400,000 and accumulated depreciation of $100,000 that sells for net proceeds of $550,000. Adjusted basis is $300,000, and the deferred gain is $250,000.
| Account | Debit | Credit |
|---|---|---|
| Accumulated Depreciation | $100,000 | |
| Exchange Proceeds Held by QI | $550,000 | |
| Relinquished Property (Original Cost) | $400,000 | |
| Deferred Gain on 1031 Exchange | $250,000 |
Read the entry line by line. The debit to accumulated depreciation zeroes the contra-asset. The credit to the property account removes the asset at its original cost. Those two lines together pull the property off the balance sheet. The debit to the QI account creates a current asset for cash you cannot yet access. The credit to deferred gain records the liability at $250,000, which is the $550,000 in proceeds minus the $300,000 adjusted basis. Debits and credits each total $650,000.
Entry to Record the Replacement Property
The second entry brings the new property on and empties the QI account. Continuing the example, assume the replacement property costs $700,000, funded with the $550,000 held by the intermediary and a new $150,000 mortgage.
| Account | Debit | Credit |
|---|---|---|
| Replacement Property | $700,000 | |
| Exchange Proceeds Held by QI | $550,000 | |
| Mortgage Payable | $150,000 |
The debit records the property at its full purchase price. The credit clears the QI account to zero. The credit to mortgage payable records the new financing. When this entry posts, the $250,000 deferred gain liability stays on the balance sheet, which is the correct result. It remains there until the replacement property is sold in a taxable transaction.
The Book Cost and the Tax Basis Are Not the Same
The $700,000 sitting on your books is the cost you paid. The tax basis for depreciation and future gain is a different number, and this is the point where records and returns fall out of sync if you are not careful. Under the statute, basis in property acquired in a like-kind exchange carries over from the property given up, adjusted for money received and gain recognized.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment A shortcut that produces the same number: purchase price minus deferred gain.
In the example, tax basis is $700,000 minus $250,000, or $450,000. The same figure comes out of adding the $150,000 in new money invested through the mortgage to the $300,000 carried-over adjusted basis. That lower basis is what preserves the deferred gain: when the replacement property is eventually sold, the taxable gain will be larger because the starting point is lower than the price paid.
When Boot Is Involved
Exchanges are rarely perfectly balanced. If you receive cash, non-like-kind property, or net debt relief (a smaller mortgage on the new property than on the old one), that is “boot.” Boot triggers recognized gain up to the lesser of the boot amount or the total realized gain.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
Say the intermediary releases $20,000 in cash to you at closing. First, book the cash coming out of the QI account:
| Account | Debit | Credit |
|---|---|---|
| Cash | $20,000 | |
| Exchange Proceeds Held by QI | $20,000 |
Then reclassify $20,000 of the deferred gain as recognized:
| Account | Debit | Credit |
|---|---|---|
| Deferred Gain on 1031 Exchange | $20,000 | |
| Recognized Gain on Sale | $20,000 |
The $20,000 recognized gain runs through the income statement and onto the return. The remaining $230,000 stays deferred. The tax basis of the replacement property increases by the amount of recognized gain, since tax has already been paid on that portion.
How Closing Costs and Loan Fees Flow Through the Entries
Broker commissions, qualified intermediary fees, title insurance, recording fees, and transfer taxes do not hit the income statement. On the relinquished side they reduce net proceeds, which reduces the realized and deferred gain. On the replacement side they increase the basis of the new asset. Either way they are recovered over time through depreciation rather than deducted immediately.
Loan-related fees are the trap. Points, loan origination fees, mortgage insurance, and lender-required appraisals are costs of obtaining financing, not costs of acquiring property. The practical test is whether the fee would exist if you paid all cash; if it would not, it is a financing cost. Financing costs paid from exchange funds can be treated as boot received, which triggers taxable gain. Paying loan fees out of the QI account is a common source of an unexpected tax bill, so route them through separate cash if possible.
What Happens If a Deadline Is Missed
A 1031 exchange runs on two hard deadlines, and missing either one kills the deferral. Every entry booked as deferred gain has to be reversed into taxable income.
The first is 45 calendar days after closing on the relinquished property. By midnight on day 45, potential replacement properties must be identified in writing.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment Weekends and holidays do not extend the date.
The second is 180 calendar days after the transfer, or the due date of the return (including extensions) for the year of the transfer, whichever comes first.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment A sale in October with an April 15 return due date shortens the 180-day window unless an extension is filed.
Tying the Entries to Form 8824
Every 1031 exchange gets reported on Form 8824, filed with the return for the year of the transfer.5Internal Revenue Service. Instructions for Form 8824 The form walks through the same arithmetic the journal entries reflect: adjusted basis, exchange expenses, boot received, recognized gain, and the calculated basis of the replacement property.
Line 15 captures cash and other non-like-kind property received, reduced by exchange expenses. Line 18 captures adjusted basis plus exchange expenses not already used on Line 15, plus net amounts paid to the other party.5Internal Revenue Service. Instructions for Form 8824 Line 25 shows the basis of the like-kind property received, and that figure should match the tax basis calculated for the replacement property.6Internal Revenue Service. Form 8824 – Like-Kind Exchanges If Line 25 does not agree with the books, reconcile before filing.
One boundary to keep in mind before booking anything: Section 1031 applies only to real property held for business or investment use. Since 2018, personal property such as equipment, vehicles, and artwork no longer qualifies.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment A personal residence does not qualify either, though mixed-use property may partially qualify under separate rules.