When a client plans to sell appreciated investment real estate, the CPA is often the first professional asked whether a 1031 exchange makes sense. The answer depends on more than the potential capital gains tax. A successful exchange requires eligible property, the correct taxpayer, a qualified intermediary, strict timing, suitable replacement property, federal and state tax analysis, and complete reporting.
This 1031 exchange checklist gives CPAs, tax advisors, financial professionals, and wealth managers a practical framework for the early conversation, while there is still time to coordinate with the client’s qualified intermediary, attorney, real estate professionals, and replacement property advisor.
1. Confirm Property and Taxpayer Eligibility
Verify investment or business use
Section 1031 applies to real property held for productive use in a trade or business or for investment. A primary residence generally does not qualify, and property held primarily for sale, such as dealer inventory or many fix-and-flip properties, is excluded. Since 2018, Section 1031 has been limited to real property.
Review the acquisition date, rental history, personal use, development activity, and original intent. Mixed-use property, vacation homes, and property converted between personal and rental use require closer analysis. For a client-friendly overview, see what qualifies as a like-kind exchange.
Confirm ownership and vesting
Identify the taxpayer that owns the relinquished property and compare that ownership with the planned purchaser of the replacement property. Individual ownership, disregarded LLCs, partnerships, corporations, and trusts may produce different results.
Review the structure before the sale contract and exchange documents are finalized. A last-minute deed transfer, partnership distribution, or ownership change can create tax concerns. When co-owners have different goals, involve tax counsel before recommending a partnership-level or separate exchange strategy.
Document taxpayer continuity across the deed, sale contract, exchange agreement, qualified intermediary statement, replacement property documents, and tax return. A disregarded single-member LLC may hold title without changing the federal tax owner, but a partnership and its partners are different taxpayers. A partnership interest generally is not real property for Section 1031 purposes, and a pre-sale distribution or post-exchange contribution can raise held-for-investment and step-transaction issues. No general federal rule makes every property safe after a fixed holding period, so record the investment purpose, rental history, and business reason for each ownership change.
Screen for related parties
Ask whether the buyer, seller, replacement property owner, or participating entity is related to the client. Related-party exchanges carry additional restrictions. The IRS Instructions for Form 8824 generally require taxpayers to file the form for the year of the exchange and for the two following years when a related-party exchange occurs. Review direct and indirect related-party structures and any applicable exceptions carefully.
2. Calculate the Federal Tax Exposure
Establish adjusted basis and realized gain
Gather the original purchase price, capital improvements, depreciation schedules, prior exchange basis, selling costs, and other basis adjustments. Separate the estimated liability into long-term capital gain, unrecaptured Section 1250 gain, other depreciation recapture, net investment income tax when applicable, and state tax.
A 1031 exchange defers qualifying gain rather than eliminating it. Form 8824 calculates deferred gain, recognized gain, and the basis of the replacement property.
Show the client both outcomes, the estimated tax from an outright sale and the projected amount deferred through a completed exchange. Our guide to capital gains tax on real estate can support that discussion.
Model equity, debt, and boot
For full deferral, determine whether the client will reinvest the exchange proceeds and replace the economic value of debt relieved at sale. Lower replacement debt may be offset with additional cash, but retained cash, non-like-kind property, or net debt relief can create taxable boot.
Review loan payoffs, prorations, credits, deposits, repair allowances, and transaction costs. Certain expenses affect the amount realized or replacement basis, while others may be treated as withdrawals from exchange funds.
Allocate the transaction among land, buildings, and property that is not real property. Furniture, equipment, prepaid rents, security deposits, credits, and other settlement items may create boot or separate tax consequences. The qualified intermediary safe harbor may disregard incidental personal property when it is typically transferred with the real estate and its aggregate fair market value does not exceed 15 percent of the aggregate fair market value of the replacement real property. That rule does not convert personal property into like-kind real property.
Test the numbers with a documented example
Assume a client sells an investment property for $2,000,000, pays $100,000 of qualifying exchange expenses, has an adjusted tax basis of $900,000, and pays off a $600,000 mortgage. The client acquires a $2,000,000 replacement property using all $1,300,000 of net exchange equity and $700,000 of new debt. Assume there is no other cash, non-like-kind property, or liability adjustment.
| Workpaper item | Amount |
|---|---|
| Relinquished property sale price | $2,000,000 |
| Less qualifying exchange expenses | ($100,000) |
| Less adjusted tax basis | ($900,000) |
| Realized gain | $1,000,000 |
| Mortgage paid at sale | $600,000 |
| Net exchange equity reinvested | $1,300,000 |
| Replacement property value | $2,000,000 |
| New replacement debt | $700,000 |
| Currently recognized gain | $0 |
| Deferred gain | $1,000,000 |
| Initial replacement property tax basis | $1,000,000 |
Workpaper result: Under these assumptions, the client reinvests all net equity, acquires replacement real estate of equal value, receives no boot, and defers the $1,000,000 realized gain. Actual results must be reconciled to the liabilities, settlement items, property allocations, and final Form 8824.
Compare full deferral with other choices
A full exchange is not always the best answer. A partial exchange may provide liquidity while deferring part of the gain. Depending on the client’s circumstances, an installment sale, charitable strategy, opportunity zone investment, or deliberate taxable sale may deserve comparison.
The CPA should quantify the tradeoffs so tax deferral does not come at the expense of liquidity, diversification, or investment suitability.
3. Review State Tax Issues
Check each relevant jurisdiction
Review the state where the relinquished property is located, the client’s resident state, and the state where each replacement property will be located. Confirm conformity with federal Section 1031 treatment, source rules, nonresident withholding, estimated tax requirements, and state-specific forms.
This is especially important when in-state real estate is exchanged for out-of-state property. The original state may continue tracking its deferred source gain.
Track clawback and annual filings
California is a useful example. Taxpayers who exchange California real property for like-kind real property outside California must file Form FTB 3840 under the current California instructions. The form is required for the exchange year and generally for each later year until the California-source deferred gain or loss is recognized.
Create a permanent state workpaper showing the deferred gain, replacement property, later exchanges, ownership changes, and final disposition. Do not assume the federal basis schedule satisfies every state requirement.
Address withholding before closing
Determine whether state nonresident withholding applies and whether an exemption, reduced withholding request, or certification is available. Coordinate with the closing agent and qualified intermediary early so withholding does not unexpectedly reduce the funds available for reinvestment.
4. Protect the Structure and Deadlines
Engage the qualified intermediary before the sale closes
The client should enter into an exchange agreement with a qualified intermediary before transferring the relinquished property. If the client receives or controls the sale proceeds, the transaction may become a taxable sale. The intermediary cannot be the taxpayer or another disqualified person under the safe-harbor rules.
Confirm that the sale contract, assignment, closing instructions, and settlement statement reflect the exchange. The 1031 exchange glossary offers plain-language definitions for clients who are unfamiliar with the process.
Calendar the 45-day and 180-day dates
Replacement property must be identified within 45 days after the transfer of the relinquished property. It must generally be acquired within 180 days or by the federal income tax return due date, including extensions, whichever comes first. Both periods run at the same time.
Calendar both dates immediately and determine whether the client will need a tax return extension. Do not assume that weekends or holidays extend the exchange periods. Qualifying IRS disaster relief may postpone a deadline in limited circumstances, so check current relief notices when a federally declared disaster affects the transaction. See the 1031 exchange timeline guide for a detailed explanation.
Review the identification plan
Confirm that the identification is written, signed, timely delivered, and specific enough to identify the property. The identification rules include the three-property rule, the 200 percent rule, and the 95 percent rule.
The three-property rule permits identification of up to three replacement properties regardless of value. The 200 percent rule permits more properties when their combined fair market value does not exceed 200 percent of the aggregate fair market value of the relinquished property or properties.
If the taxpayer identifies more properties than those rules permit, the 95 percent rule can preserve the identification only when the taxpayer receives identified replacement property with a fair market value of at least 95 percent of the aggregate fair market value of everything identified. Because this exception is demanding, encourage a viable backup while keeping the identification list disciplined.
5. Evaluate Replacement Property Options
Compare direct property, NNN, TIC, and DST ownership
Replacement property may include a directly owned rental, multifamily property, commercial building, triple-net lease property (NNN), tenant-in-common interest (TIC), or properly structured Delaware statutory trust interest (DST).
A DST can qualify as replacement real property when it meets the structure described in Revenue Ruling 2004-86 and the remaining Section 1031 requirements are satisfied. Publicly traded and non-traded REIT shares generally do not qualify as direct like-kind replacement property.
Clients seeking passive ownership, built-in financing, diversification, or a faster closing may consider DSTs. The step-by-step DST exchange process explains the qualified intermediary, identification, subscription, and closing stages.
Test investment suitability
Tax qualification is only one part of the decision. Review expected cash flow, leverage, hold period, sponsor experience, fees, reserves, tenant concentration, lease rollover, property type, location, liquidity restrictions, and exit assumptions.
For DSTs and other private offerings, confirm investor eligibility and allow time to review the private placement memorandum and due diligence. A property should not be selected merely because it can close before day 180.
Confirm financing and closing capacity
Calculate the replacement debt needed and confirm that the client can close within the exchange period. Direct ownership may involve lender, appraisal, and inspection risk. DST debt is commonly arranged at the trust level, but the allocation must still match the client’s tax calculations and financial goals.
If the client plans to split proceeds among several replacement properties, verify the equity and debt allocation for each acquisition. Review the combined transaction as one exchange rather than as several unrelated purchases.
6. Complete Reporting and Preserve Records
Reconcile the final transaction
Collect the sale and purchase statements, qualified intermediary statement, identification notice, exchange agreement, loan documents, and ownership records. Reconcile the final numbers against the initial tax estimate.
File Form 8824 with the federal return for the year in which the relinquished property was transferred, even when no gain is currently recognized. Maintain schedules for realized gain, recognized gain, deferred gain, carryover basis, depreciation basis, boot, liabilities, and exchange expenses.
Build the post-exchange depreciation workpapers
Do not stop with Form 8824. For depreciable replacement real estate, prepare separate schedules for the carryover or exchanged basis and any excess basis. Under Treasury Regulation section 1.168(i)-6, carryover basis generally continues over the remaining recovery period using the prior depreciation method and convention, while excess basis generally is treated as newly placed in service. Evaluate whether the election under section 1.168(i)-6(i) is appropriate, prepare any required timely election statement, and reconcile land, building, and component allocations to Form 4562.
Do not automatically release suspended passive activity losses. Full release generally requires a disposition of the taxpayer’s entire interest in a fully taxable transaction with an unrelated person. A fully deferred 1031 exchange typically does not satisfy that requirement. Carry forward the suspended-loss schedules and coordinate them with the replacement activity, at-risk limitations, and state adjustments.
Maintain state and future-exchange schedules
Carry federal and state deferred-gain schedules forward. Track improvements, refinancings, partial sales, casualty events, entity changes, and later exchanges.
For DST interests, a future trust sale may lead to another exchange, recognition of the deferred gain, or an estate planning decision. Advance communication is important because the client may receive a relatively short notice period before the DST sale closes.
The 1031 DST frequently asked questions can help answer client questions about deadlines, debt, income, and the eventual DST sale.
CPA Client Meeting Checklist
Before the relinquished property closes, confirm that you have:
- Verified investment or business use.
- Reviewed ownership, vesting, and taxpayer continuity.
- Screened for related-party and partnership issues.
- Calculated basis, gain, recapture, net investment income tax, and state tax.
- Modeled equity, replacement debt, liquidity, and possible boot.
- Reviewed state conformity, withholding, sourcing, and filing requirements.
- Confirmed that a qualified intermediary is engaged before closing.
- Calendared the 45-day and 180-day deadlines.
- Reviewed the three-property, 200 percent, and 95 percent identification rules.
- Compared direct property, NNN, TIC, DST, and partial-exchange options.
- Established a plan for Form 8824, state forms, basis, depreciation, and permanent records.
- Allocated real property, personal property, rents, deposits, credits, liabilities, and exchange expenses.
- Confirmed whether a reverse or improvement exchange must be structured before the client acquires or improves the replacement property.
- Prepared carryover and excess depreciation basis schedules and reviewed suspended passive activity losses.
Help Your Client Build a Workable Replacement Property Plan
The strongest 1031 exchange plans begin before the sale closes. When a CPA identifies the tax exposure early and coordinates with the qualified intermediary, attorney, and replacement property team, the client has more time to compare investments, manage debt, and avoid deadline pressure.
1031 DST works alongside CPAs, tax professionals, financial advisors, attorneys, and qualified intermediaries to help clients evaluate DST replacement properties and complete the investment side of a 1031 exchange.
Schedule a consultation to discuss your client’s timeline, equity, debt, income goals, and available DST replacement property options.
