A journal entry for a 1031 exchange has two main parts: one entry removes the relinquished property and parks the sale proceeds in an account held by the qualified intermediary while creating a deferred gain liability, and a second entry brings the replacement property onto the books and clears the intermediary account. The deferred gain stays on the balance sheet as a liability until you eventually sell the replacement property in a taxable transaction. Everything else — boot, closing costs, basis adjustments — is a variation on those two entries.
The Two Numbers You Need Before Posting Anything
Two figures drive every line of the entry: the adjusted basis of the property you are giving up, and the deferred gain on the sale.
Adjusted basis is what you originally paid, plus capital improvements, minus all depreciation claimed during the holding period.1Internal Revenue Service. Topic No. 703, Basis of Assets That is the amount of your investment the IRS still considers unrecovered.
Deferred gain is net sale proceeds (sale price minus selling expenses) minus adjusted basis. In a fully qualifying exchange with no cash or non-like-kind property coming back to you, the entire gain is deferred rather than recognized.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
The running example below assumes an original property cost of $400,000, accumulated depreciation of $100,000, and net sale proceeds of $550,000. Adjusted basis is $300,000. Deferred gain is $250,000.
Entry One: Removing the Relinquished Property
The first entry touches four accounts: the original asset, its accumulated depreciation, a temporary current asset for funds held by the qualified intermediary, and a new deferred gain liability.
A qualified intermediary is an independent third party who holds the sale proceeds during the exchange period. If you touch the money yourself, the IRS treats you as having received it, which disqualifies the exchange.3Internal Revenue Service. Fact Sheet FS-2008-18 – Like-Kind Exchanges Under IRC Section 1031 Treasury regulations also bar you from using someone who already works for you (attorney, accountant, real estate agent), and the exchange agreement must expressly limit your access to the funds before closing.4GovInfo. Treasury Regulation 1.1031(k)-1 That is why the proceeds sit in a separate asset account on your books rather than in regular cash.
| 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 |
The logic: debiting accumulated depreciation zeroes out that contra-asset. Crediting the property account removes the asset at original cost. Those two lines together strip the old property off the balance sheet. The debit to the QI account creates a current asset for cash you cannot access yet. The credit to deferred gain creates a liability equal to proceeds minus adjusted basis ($550,000 less $300,000). The entry balances at $650,000 on each side.
Entry Two: Bringing on the Replacement Property
The second entry records the new property and clears the QI holding account. Suppose you buy a replacement for $700,000, using the $550,000 from 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 books the new property at its full purchase price. The credit zeros out the temporary QI asset. The mortgage credit records the new financing. The $250,000 deferred gain liability stays on the balance sheet, which is the point. It lives there until you sell the replacement property in a taxable transaction.
Book Cost vs. Tax Basis of the Replacement Property
The $700,000 purchase price on your books is not the same number as the tax basis you will use for depreciation and future gain. Under the statute, the basis of property received 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 gets to the same answer: purchase price minus deferred gain.
In the example, tax basis is $700,000 minus $250,000, or $450,000. You can also arrive at $450,000 by adding the $150,000 of new mortgage money to the old $300,000 adjusted basis. The lower basis is what preserves the deferred gain for later. When you eventually sell, your taxable gain starts from $450,000, not $700,000.
Keep a schedule outside the general ledger that tracks the carryover basis separately from the book value. The two numbers diverge the moment the second entry posts, and the tax figure is the one that drives Form 4562 depreciation and future Form 8824 reporting.
When Boot Changes the Entries
If the exchange is not perfectly balanced, you may receive boot: cash, non-like-kind property, or net debt relief. A smaller mortgage on the new property than on the old one counts as money received. Boot triggers taxable 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 you take $20,000 in cash at closing from the intermediary. First, record the cash:
| Account | Debit | Credit |
|---|---|---|
| Cash | $20,000 | |
| Exchange Proceeds Held by QI | $20,000 |
Then reclassify the portion of the gain that just became taxable:
| Account | Debit | Credit |
|---|---|---|
| Deferred Gain on 1031 Exchange | $20,000 | |
| Recognized Gain on Sale | $20,000 |
The $20,000 flows through the income statement and onto the tax return. The remaining $230,000 stays in the deferred liability. The tax basis of the replacement property increases by the recognized gain, since tax has already been paid on that slice of profit.
Where Closing Costs Post
Exchange closing costs do not hit the income statement. Broker commissions, qualified intermediary fees, title insurance, recording fees, and transfer taxes are costs of the transaction. On the sell side, they reduce net proceeds and therefore reduce realized gain. On the buy side, they increase the basis of the new asset. Either way, they get recovered through depreciation rather than expensed immediately.
Loan-related fees are a separate category and a common source of surprise. Points, origination fees, mortgage insurance, and lender-required appraisals are costs of obtaining financing, not of acquiring the property. The test is whether the cost would exist if you paid all cash; if not, it is a financing cost. Paying financing costs out of exchange funds can be treated as boot received, which triggers taxable gain. Route those payments through regular cash, not through the QI account.
What Would Force You to Reverse the Deferred Gain
Two deadlines control whether the deferral survives. Miss either one and every entry booked as deferred gain reverses into taxable income.
The first is 45 calendar days after you close on the relinquished property. By midnight on the 45th day, you must identify potential replacement properties in writing.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment No extensions for weekends, holidays, or anything else.
The second is 180 calendar days after the transfer, or the due date of your 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 Closing on a replacement property must happen within that window. An October sale with an unextended April return gets a shortened window; filing an extension protects the full 180 days.
Related-party exchanges carry a second trigger. If you exchange with family or with entities you or your family control, both sides must hold the swapped properties for at least two years. Early disposition by either party snaps the deferred gain back as taxable on the date of that disposition.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment For bookkeeping, that means the deferred gain liability on a related-party exchange is not settled until the two years pass.
One boundary worth stating plainly: Section 1031 applies only to real property held for business or investment use. Personal property like equipment, vehicles, or artwork has not qualified since 2018, and a personal residence does not qualify either.2Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment If your transaction falls outside those limits, none of these entries apply.
Reconciling 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 math that drove your journal entries: adjusted basis, exchange expenses, boot, recognized gain, and the 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 number should equal the tax basis you calculated for the replacement property.6Internal Revenue Service. Form 8824 – Like-Kind Exchanges If Line 25 does not agree with the carryover basis on your books, either the entries or the form has a problem. Reconcile before you file.