Recording 1031 exchange accounting journal entries means keeping two sets of books in your head at once: GAAP wants you to recognize the full gain at fair value, and the tax code wants you to defer it. The disposal entry clears the old property and books a GAAP gain; the acquisition entry puts the replacement on the balance sheet at fair market value; and a third entry captures the deferred tax liability created because the tax basis of the new property is lower than its GAAP basis. Everything else — boot, capitalized closing costs, mortgage payoffs, depreciation — plugs into those three entries.
Why GAAP and Tax Produce Different Numbers
Under ASC 845, a nonmonetary exchange with commercial substance is measured at fair value, and the gain or loss is recognized in the current period. Real estate exchanges almost always meet that test because swapping one investment property for another changes the cash flow profile of the business. So GAAP records a gain today and puts the new asset on the books at fair value.
Section 1031 does the opposite. If you meet the exchange rules and reinvest all proceeds into qualifying real property, the gain is deferred and the replacement property inherits a reduced tax basis carried over from the old property. That gap between GAAP basis and tax basis is the deferred gain, and it drives the deferred tax entry you need to book alongside the exchange itself.
A quick boundary worth stating: since 2018, Section 1031 applies only to real property. Personal property, equipment, and intangibles no longer qualify.1Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
Entry 1: Removing the Relinquished Property
The disposal entry has four moving parts: reverse the historical cost, reverse the accumulated depreciation, book the receivable from your Qualified Intermediary for the sale proceeds, and record the GAAP gain (or loss).
Take a property with a historical cost of $1,000,000, accumulated depreciation of $300,000 (net book value $700,000), sold for $1,200,000. The realized GAAP gain is $500,000. The entry:
- Debit Accumulated Depreciation $300,000
- Debit Receivable from Qualified Intermediary $1,200,000
- Credit Relinquished Property $1,000,000
- Credit Gain on Exchange $500,000
The QI Receivable is a temporary asset. It sits on the balance sheet until the intermediary uses the funds to buy the replacement property. Economically the money is yours; the QI just holds it to preserve the exchange structure required under Section 1031.
If the Old Property Had a Mortgage
Any existing mortgage is typically paid off at closing before the QI receives net proceeds. Add a debit to Mortgage Payable for the payoff and reduce the QI Receivable by the same amount. If the property above carried a $400,000 mortgage, the QI would hold $800,000 in net proceeds, and the entry would include a $400,000 debit to Mortgage Payable with an $800,000 debit to the QI Receivable instead of $1,200,000.
On the tax side, debt relief counts as boot received. New debt taken on for the replacement can offset that relief, so track both figures when working out whether any taxable boot exists at year end.
Entry 2: Recording the Replacement Property
The acquisition entry puts the new asset on the books at its purchase price (fair value for GAAP) and clears the QI Receivable. Continuing the example, assume you buy a $2,000,000 replacement using the $1,200,000 held by the QI plus an $800,000 new mortgage:
- Debit Replacement Property $2,000,000
- Credit Receivable from Qualified Intermediary $1,200,000
- Credit Mortgage Payable $800,000
Every funding source shows up as a credit here. If you added cash out of pocket, credit Cash for that amount. If you assumed an existing loan on the new property, credit Mortgage Payable for that balance. The replacement should end up capitalized at its full acquisition cost.
Entry 3: The Deferred Tax Liability
This is the entry preparers most often miss. Because GAAP recognized a gain and recorded the new property at fair value, while the tax return defers the gain and carries a lower basis forward, you have a taxable temporary difference under ASC 740.
The temporary difference equals the deferred gain. In the example, GAAP basis on the replacement is $2,000,000 and tax basis is $1,500,000 (old adjusted tax basis of $700,000 plus the $800,000 in additional investment through the new mortgage). The $500,000 gap matches the gain recognized for GAAP but deferred for tax. At a 21 percent corporate rate, the deferred tax liability is $105,000:
- Debit Income Tax Expense $105,000
- Credit Deferred Tax Liability $105,000
That liability stays on the balance sheet until the replacement is sold in a taxable transaction, or unwinds gradually as the two depreciation schedules diverge. If the entity is a partnership or S corporation, the deferred tax entry lives at the owner level, not on the entity’s books, but the basis difference still needs disclosure.
Tax Basis of the Replacement Property
Statutory formula: adjusted basis of the property given up, minus money received, plus any gain recognized. In a fully deferred exchange with no boot, tax basis equals old adjusted basis plus net additional investment (new cash or net new debt).
Running the numbers from the example: $700,000 old basis, no boot, no recognized gain, plus $800,000 of new mortgage produces a $1,500,000 tax basis on a property carried at $2,000,000 for GAAP. The $500,000 gap is the deferred gain that will resurface when you eventually sell. Both the realized and the recognized gain get reported on Form 8824 for the year of the exchange.2Internal Revenue Service. IRS Form 8824 – Like-Kind Exchanges
Handling Boot
Boot is any non-like-kind property that changes hands, usually cash or net debt relief.
Boot Paid
If you kick in extra cash to close the price gap, that cash simply increases the replacement’s basis for both GAAP and tax. Debit Replacement Property, credit Cash. No special treatment.
Boot Received
Cash boot doesn’t change the GAAP gain (already fully recognized), but it triggers recognized gain for tax up to the lesser of the boot or the total realized gain. If the QI distributes $50,000 of cash to you instead of rolling it into the new property, the entry is:
- Debit Cash $50,000
- Credit Receivable from Qualified Intermediary $50,000
That $50,000 becomes recognized gain on Form 8824 and reduces the deferred gain — and therefore the deferred tax liability — by the corresponding tax amount.3Internal Revenue Service. Instructions for Form 8824
Which Closing Costs Get Capitalized
Costs tied directly to acquiring the replacement get debited to the Replacement Property account: title insurance, escrow fees, QI fees, transfer taxes. They increase the depreciable basis for GAAP and, where applicable, for tax.
Costs tied to operating the property or financing the deal get expensed or amortized separately. Prorated property taxes and insurance premiums covering the operating period hit expense (or prepaid) accounts. Loan origination fees are amortized over the loan term rather than capitalized to the asset. Miscategorizing here matters: capitalize an operating cost and you overstate depreciable basis; expense an acquisition cost and you understate it.
Depreciation After the Exchange
Because the two bases start at different numbers, the depreciation schedules diverge on day one, and each year’s entry has to reflect both.
For GAAP, depreciate the fair-value basis (less land) over the property’s estimated useful life. It is a fresh-start schedule tied to your estimate for that specific asset, not a statutory recovery period.
For tax, the IRS splits the replacement’s basis into two layers. The “exchanged basis” — the carryover from the relinquished property — continues the old depreciation method and remaining recovery period as if nothing happened. The “excess basis” — additional investment above the carryover — is treated as a newly acquired asset and depreciated over a fresh 27.5-year period for residential rental or 39 years for nonresidential. You can elect on Form 4562 to treat the whole replacement as a new asset, which simplifies the math but may cost you deductions depending on where the old asset stood in its recovery period.
Each year, the gap between GAAP depreciation and tax depreciation moves the deferred tax liability up or down. That adjustment is a recurring journal entry for the life of the property.
Deadlines and Situations That Undo the Entries
Two hard deadlines control whether the exchange qualifies at all. You have 45 calendar days from transferring the relinquished property to identify replacements in writing, and 180 days from that same transfer date (or the due date of your return with extensions, whichever comes first) to close.4Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment Miss either and Section 1031 is gone. The QI Receivable becomes ordinary cash proceeds, the GAAP gain stays the same, and the full gain is currently taxable. There is no deferred tax liability to book; instead you record a current income tax payable.
Related-party exchanges add a two-year holding requirement on both sides. If either party disposes of the property received within two years, the deferral unwinds and the deferred gain becomes taxable in the year of the early disposition.4Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment Related parties include family members, an individual and a more-than-50-percent-owned corporation, commonly controlled corporations, and various trust relationships.5Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers The IRS also blocks structures that route an exchange through an intermediary so a related party can cash out while the taxpayer claims deferral.6Internal Revenue Service. Rev. Rul. 2002-83 During the two-year window, a material deferred gain warrants footnote disclosure of the contingency.