How do I Report a 1031 Exchange to the IRS?

When completed properly, a 1031 Exchange can help defer capital gains and depreciation recapture taxes from the sale of real estate used for investments or business purposes. However, following the proper procedures is only part of the story. Reporting the exchange on your annual tax return is essential when complying with the IRS’ like-kind exchange regulations.

When to Report

You would report a like-kind exchange transaction on your tax return for the year during which you sold the relinquished property—even if the exchange wasn’t completed in the same year. For example, if you started the exchange in December, 2023 and completed it in March, 2024, you would report it with your 2023 tax return.

If the replacement property acquisition occurs after the tax filing deadline, you may need to request a filing extension to ensure the exchange is reported accurately and in compliance with IRS rules. 

How to Report

You must fill out specific forms detailing the exchange, which are combined with your Form 1040 and submitted to the IRS. The two forms involved are as follows:

Form 8824: Presenting Details of the Exchange

Form 8824, “Like-Kind Exchanges,” gives the IRS specifics about the activity. The form is divided into four sections, and requests information including:

• A description of the relinquished property and when it was sold
• A description of the replacement property, when it was identified, and when you received it
• Information about related parties involved, if any
• Realized gain (or loss) and recognized gain
• Fair market value of the relinquished property
• Basis of the replacement property and adjusted basis of the relinquished property

Keep in mind that you must file a separate Form 8824 for each exchange.

Form 4797/Schedule D: Outlining the Taxable Gain

The receipt of cash, or “boot,” as part of the exchange is considered a taxable gain. As such, you might need to complete Form 4797 (“Sales of Business Property”) if you receive cash proceeds from a 1031 exchange. In this case, information would include:

1. The property’s description, date acquired, and date sold
2. Gross sales price
3. Allowable depreciation
4. Cost or other basis
5. Ordinary gains or losses

In some instances, you might also need to fill out a Schedule D (Form 1040), which outlines the capital gains and losses involved with your exchange. Additional forms (like 4562, 6252, Schedule E, or state-specific forms) may also be needed depending on the nature of the transaction, the property involved, and the taxpayer's unique circumstances. 

Additional Paperwork

Along with the above-mentioned forms, the IRS might require more proof that you followed the 1031 exchange rules. If this is the case, you might be asked to provide supporting documentation that could include:

• Evidence that you complied with the exchange timelines (45 days to identify a replacement property, 180 days to close on it)
• A copy of the exchange agreement with your Qualified Intermediary (QI)
• Closing documents for the relinquished and replacement properties

Proper Reporting: An Important Exchange Activity

Knowing the correct forms to complete and file with your tax return can mean fewer questions or audits from the IRS concerning your 1031 exchange. Be sure to offer the correct information about the properties exchanged, correctly calculate gain or boot, and maintain in-depth records to support your actions.

It’s a good idea to work with a tax professional to ensure that the correct information about your exchange is submitted to the IRS. Working with this individual can help save you time, while avoiding potential and costly issues down the road.

The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.