How Do I Book a 1031 Exchange in My Rental Books?

What leaves the books when the relinquished property closes?

Everything attached to that property comes off the balance sheet on the closing date, in one entry built from the settlement statement. Four things move:

• The property at cost. Land, building, and every capital improvement recorded against it, at the amounts they were carried at. If improvements were tracked the way the improvements register article describes, this is a list you already have.
• Its accumulated depreciation. The contra-asset balance, entered over the years from your CPA’s schedule, comes off with the property.
• The loan paid off at closing. The mortgage principal is cleared. The payoff figure on the statement should match the balance sheet to the dollar before you post.
• Closing costs. Commission, title, and transfer charges, recorded in a clearly labeled disposal-costs account so the CPA sees them as one group.

The entry will not balance on its own. The difference goes to a gain or loss on disposal line. That number is a balancing figure; how it is treated on the return is your CPA’s determination. If the two closings straddle a year end, ask your CPA before the books close whether that figure should sit on the balance sheet as a deferred item until the replacement closes, so one year’s net income does not carry a gain the next year reverses.

How do I carry the funds the intermediary is holding?

The net proceeds go from the closing table to the qualified intermediary, and they stay there until the replacement closes. In the books they are an asset, in an account named for the exchange: something like “Exchange funds held by intermediary.” Three rules keep it clean:

• Not cash. You cannot spend it, so it does not belong in a bank account on the balance sheet. A separate asset or receivable account is the right home.
• Not income. The proceeds are the other side of the disposal entry. Nothing about the sale touches the profit and loss except the disposal line and the costs beside it.
• Reconciled to the intermediary’s statement. Treat the intermediary like a bank. Their statement is the source, and the account balance should agree with it at every month end. Interest or fees on their statement get their own labeled lines.

“Exchange funds are the one balance on a landlord’s balance sheet that nobody can spend. Carry them as an asset, reconcile them like a bank account, and leave the tax questions to the person filing the return.”

What gets recorded when the replacement property closes?

The second settlement statement is the source document, entered as a single entry on the closing date. Three things land:

• The replacement property, at the basis your CPA gives you. In an ordinary purchase the property goes on at the price paid. In an exchange, the starting basis is a figure your CPA calculates and hands you, split between land and building. Enter it as given. Do not compute it. If the closing happens before the CPA has the number, post the entry with a clearly labeled placeholder line and replace it when the figure arrives.
• The new loan. The mortgage on the replacement goes on as a liability at the principal amount shown on the statement.
• The exchange account cleared to zero. The intermediary wires the held funds to the closing, the exchange asset comes off, and the account should end at exactly zero.

Any difference between the CPA-supplied basis and the cash and loan that actually moved is posted where the CPA directs, usually against the disposal line from the first entry. Ask for the instruction rather than inventing a plug.

What does my CPA need from the bookkeeper?

Four items:

• Both settlement statements, the relinquished sale and the replacement purchase, as the closing agent issued them.
• Every intermediary statement, from the first deposit to the final zero balance, including the intermediary’s fee invoice.
• The improvement schedule for the relinquished property. Each capital improvement with its date, cost, and invoice, back to the day you bought it. This is the item most often missing, and the record retention article covers why those invoices should still be on file.
• Clean books through both closing dates. Reconciled bank and loan accounts, and a balance sheet where the old property, its depreciation, and its loan are gone, and the new property, the new loan, and a zeroed exchange account are present.

The CPA takes it from there. The identification and closing deadlines, the like-kind test, deferred gain, and anything referred to as boot are tax determinations, and they are not covered here. The broader year-end handoff is in what your CPA needs at year end.

The Bottom Line

A 1031 exchange is two closings and a holding period, and the books follow that shape. At the first closing, the property, its depreciation, its loan, and the closing costs come off, with the difference on a disposal line. In between, the proceeds sit in an exchange asset account reconciled to the intermediary. At the second closing, the replacement goes on at the basis the CPA supplies, the new loan goes on, and the exchange account returns to zero.

Real Cents Organized is a bookkeeping firm. We record and organize the books; your CPA determines the filing position, the basis figures, the depreciation schedules, and what any of this means on your return.

Frequently asked questions

Should the exchange proceeds show up as cash in my books?

No. The intermediary holds the money and you cannot spend it, so it does not belong in a bank account. Carry it in a separate asset account named for the exchange, reconcile that account to the intermediary’s statement each month, and clear it to zero when the funds are applied at the replacement closing.

What number do I use for the replacement property’s basis?

The figure your CPA gives you. In an exchange, the starting basis of the replacement property is a tax calculation, split between land and building, and the bookkeeper enters it exactly as supplied. If the closing happens before the CPA has the number, post a clearly labeled placeholder line and replace it when the figure arrives.

Does a bookkeeper track the exchange deadlines?

Deadline tracking, the like-kind test, deferred gain, and boot are tax matters that sit with your CPA and the qualified intermediary. The bookkeeper’s part is narrower: both settlement statements, every intermediary statement, the relinquished property’s improvement schedule, and reconciled books through both closing dates, handed over promptly so nothing has to be rebuilt.