How to Report a 1031 Exchange on Your Tax Return

A 1031 exchange allows real estate investors to defer capital gains taxes by reinvesting proceeds from a property sale into a similar property. While this tax benefit is significant, it comes with strict IRS reporting requirements that must be followed to ensure compliance and avoid penalties.

Properly documenting the transaction on your tax return is essential. Mistakes or omissions could lead to audits or unexpected tax liabilities. Understanding how to report a 1031 exchange correctly will help you maximize benefits while staying within IRS guidelines.

Filing Requirements

The IRS requires taxpayers to report a 1031 exchange using Form 8824, Like-Kind Exchanges, filed with their federal tax return for the year the exchange occurred. This form details the properties involved, transaction timeline, and any taxable gain. Failing to submit it or providing incomplete information can result in penalties or increased scrutiny.

Form 8824 has four sections. The first records basic details, including descriptions of the relinquished and replacement properties, transfer dates, and whether the exchange was completed within the required 180-day period. The second calculates any taxable gain, requiring disclosure of fair market values and any liabilities assumed or relieved. The third applies to related-party exchanges, which have additional restrictions to prevent tax avoidance. The final section reports deferred exchanges from prior years still open.

Beyond Form 8824, taxpayers must ensure consistency across their entire return. The adjusted basis of the replacement property must align with future depreciation schedules, and any debt relief or cash received should match amounts reported elsewhere, such as on Schedule D or Form 4797. Discrepancies can trigger IRS inquiries.

Calculating Boot

Any value received in a 1031 exchange that does not qualify as like-kind property is considered “boot” and may be subject to capital gains tax. Boot can take the form of cash, debt relief, or non-like-kind property, all of which impact tax consequences.

Cash boot arises when the replacement property is worth less than the relinquished property, leading to excess proceeds not reinvested. For example, if an investor sells a property for $500,000 and buys a replacement for $450,000, the $50,000 difference is cash boot and taxable as a capital gain.

Debt boot occurs when the mortgage or liabilities on the replacement property are lower than those on the relinquished property. If an investor sells a property with a $300,000 mortgage but acquires a replacement with only $250,000 in debt, the $50,000 reduction is taxable boot unless offset by additional cash investment. The IRS considers debt relief a form of gain because it improves the taxpayer’s financial position.

In some cases, a taxpayer may receive personal property, such as equipment or furniture, as part of the exchange. Since personal property does not qualify under the exchange rules, its fair market value is treated as boot and taxed accordingly. This is particularly relevant in commercial real estate transactions where business assets are sometimes included.

Adjusting Basis

After a 1031 exchange, determining the adjusted basis of the newly acquired property is necessary for future tax calculations, including depreciation and gain recognition upon sale. The basis of the replacement property is not simply its purchase price but is derived from the relinquished property’s basis, adjusted for additional expenditures, boot received, and transaction costs.

To calculate the adjusted basis, start with the carryover basis of the relinquished property—typically the original purchase price plus capital improvements, minus depreciation claimed. Any cash or non-like-kind property contributed to the exchange increases the basis, while boot received reduces it. Certain costs, such as intermediary fees, legal expenses, and recording fees, can also be added to the basis instead of being deducted as an immediate expense.

Depreciation calculations must be based on this adjusted basis, using the appropriate recovery period under the Modified Accelerated Cost Recovery System (MACRS). The portion of the basis carried over from the relinquished property continues with the same depreciation schedule, while any additional basis from new investment is treated separately with a new recovery period. This distinction is critical for investors optimizing tax deferral strategies while ensuring compliance.

Reporting Like-Kind Property

Accurately reporting the properties involved in a 1031 exchange requires careful attention to detail. Each property must be identified on Form 8824, with descriptions including the legal address, acquisition and disposition dates, and fair market values at the time of exchange. Both the relinquished and replacement properties must meet the like-kind standard, meaning they must be of the same nature or character, even if they differ in quality. While most real estate qualifies, exceptions exist, such as property held primarily for sale, which does not meet the criteria under Treasury regulations.

Timing is crucial, as the IRS enforces strict deadlines for property identification and transaction completion. The 45-day identification period requires taxpayers to formally designate potential replacement properties in writing, while the 180-day rule dictates when the exchange must be finalized. Missing these deadlines results in disqualification, making any realized gain immediately taxable. Documentation should reflect adherence to these timeframes to support the exchange’s validity in case of IRS review.

Record Retention

Maintaining thorough documentation of a 1031 exchange is necessary for substantiating the transaction in case of an IRS audit. Inadequate records can result in penalties, disqualification of the exchange, or additional tax liabilities. Since exchanges often affect multiple tax years due to depreciation and future sales, proper record-keeping ensures compliance and simplifies future reporting.

Taxpayers should retain copies of Form 8824, settlement statements, purchase and sale agreements, and any correspondence with a qualified intermediary. These documents verify that the exchange was structured correctly and that all deadlines were met. Additionally, records of property improvements, depreciation schedules, and cost basis calculations should be preserved, as they impact future tax obligations. The IRS generally requires taxpayers to keep records for at least three years after filing, but since 1031 exchanges affect long-term capital gains, retaining them indefinitely is advisable.