Recording a 1031 exchange on your books involves several steps to ensure that the transaction is accurately reflected in your financial records. A 1031 exchange allows you to defer capital gains taxes by exchanging like-kind properties, and it's crucial to document this process correctly to maintain compliance with IRS regulations. Here's a detailed guide on how to record a 1031 exchange on your books, using an example to illustrate the process.

Step-by-Step Guide to Recording a 1031 Exchange

1. Identify the Relinquished Property: Start by identifying the property you are selling (relinquished property). Record the sale of this property in your books. This involves removing the asset from your balance sheet and recognizing any accumulated depreciation.
2. Calculate the Adjusted Basis: Determine the adjusted basis of the relinquished property. This includes the original purchase price, plus any capital improvements, minus accumulated depreciation. This calculation is essential for determining the realized gain or loss on the sale.
3. Record the Sale of the Relinquished Property:
   • Debit the accumulated depreciation account for the total depreciation taken on the property.
   • Credit the property account for the original cost of the property.
   • Record any selling expenses, such as commissions or closing costs, as a debit to an expense account.
   • If there is a mortgage payoff, record this as a debit to the mortgage payable account.
4. Use Deferred.com as the Qualified Intermediary: As part of the 1031 exchange, you will use Deferred.com as your qualified intermediary. We will hold the proceeds from the sale of the relinquished property. This ensures you do not have constructive receipt of the funds, which is crucial for maintaining the tax-deferred status of the exchange.
5. Identify and Acquire the Replacement Property:
   • Within 45 days of selling the relinquished property, identify potential replacement properties. You must acquire the replacement property within 180 days.
   • Record the purchase of the replacement property. This involves debiting the property account for the purchase price and crediting the cash or exchange proceeds account for the amount paid.
6. Record the Exchange: When you acquire the replacement property, record the transaction as an exchange rather than a sale and purchase. This involves adjusting the basis of the new property to reflect the deferred gain from the relinquished property. The new basis is calculated as the adjusted basis of the relinquished property, plus any additional cash paid, minus any liabilities assumed by the buyer of the relinquished property.

Example

Let's say you sold a rental property for $500,000, which you originally purchased for $300,000. You used Deferred.com as your qualified intermediary. The property had $100,000 in accumulated depreciation, and you incurred $20,000 in selling expenses. You identified and purchased a replacement property for $550,000.

• Relinquished Property:
  • Original Cost: $300,000
  • Accumulated Depreciation: $100,000
  • Adjusted Basis: $200,000 ($300,000 − $100,000)
  • Selling Expenses: $20,000
• Journal Entries for Relinquished Property:
  • Debit Accumulated Depreciation: $100,000
  • Credit Property Account: $300,000
  • Debit Selling Expenses: $20,000
  • Debit Mortgage Payable (if applicable): [amount]
  • Credit Cash/Exchange Proceeds: $500,000
• Replacement Property:
  • Purchase Price: $550,000
  • New Basis: $200,000 (Adjusted Basis of Relinquished Property) + $50,000 (Additional Cash Paid) = $250,000
• Journal Entries for Replacement Property:
  • Debit Property Account: $550,000
  • Credit Cash/Exchange Proceeds: $500,000
  • Credit Cash (Additional Paid): $50,000

By following these steps and using Deferred.com as your qualified intermediary, you can ensure that your 1031 exchange is accurately recorded on your books, maintaining compliance with IRS regulations and deferring capital gains taxes effectively. Always consult with a tax professional to ensure all aspects of the exchange are handled correctly.