What does a 1031 exchange look like in your books?

A 1031 exchange doesn’t eliminate the gain on your property sale. It defers it by moving the old property’s tax basis into the new one. Getting this right in your books matters because errors here follow you for years and create real problems when you eventually sell the replacement property or get audited.

When you sell the relinquished property, you remove it from your books. The asset account and accumulated depreciation both get cleared. But unlike a normal sale, you don’t book a realized gain. Instead, the sale proceeds flow to your qualified intermediary. In your accounting system, this should show as a receivable from the QI or a dedicated exchange proceeds account. The money should never touch your operating bank account. If it does, even briefly, you risk disqualifying the entire exchange. Your books need to clearly show that those funds stayed with the QI throughout the exchange period.

When you close on the replacement property, here is where most bookkeeping mistakes happen. The new property does not go on your books at its purchase price. It goes on at what is called “exchange basis,” which is the adjusted basis of the old property you gave up, plus any additional cash (boot) you paid out of pocket, plus closing costs and exchange expenses. If the replacement property cost more than the relinquished property sold for and you added cash to make up the difference, that additional amount gets added to the carryover basis.

If you received boot, meaning the QI returned cash to you or you received non-like-kind property, you recognize gain to the extent of that boot. That portion is taxable in the year of the exchange and needs to be booked as a recognized gain.

Depreciation on the replacement property requires careful attention. The carryover basis from the old property and any new basis from boot paid are treated differently for depreciation purposes. The carryover portion generally continues using the same method and life as the original property, while any additional basis from boot gets its own depreciation schedule. Your real estate accountant or tax preparer should guide the specific treatment, but your books need to support it with the right cost basis recorded from day one.

Document everything in a way that supports Form 8824 at tax time. Keep the QI agreement, closing statements for both properties, identification letters for the replacement property, and a clear calculation showing how you arrived at the new basis. These records should tie directly to what is in your accounting system. If the numbers in your books don’t match the exchange documentation, someone made an error that needs to be found before the return gets filed.

For Northern Virginia small business bookkeeping services clients running rental portfolios, we see 1031 exchanges handled incorrectly more often than correctly. The most common mistake is recording the replacement property at its fair market value instead of the exchange basis. That overstates your depreciable basis, gives you larger depreciation deductions than you are entitled to, and creates a mess when you eventually dispose of the property. The second most common mistake is letting QI proceeds flow through the operating account and then trying to sort it out later.

Get the bookkeeping right at the time of the exchange. Fixing it after the fact is significantly more work and often requires amending returns.