Is it OK to payoff a mortgage just prior to doing a 1031 exchange? Timing question

This is a great question about 1031 exchanges. Paying off your mortgage just before a 1031 exchange won't disqualify the exchange, but there are some important considerations to keep in mind. The key is understanding how "boot" works in a 1031 exchange. When you do an exchange, you need to reinvest all of the proceeds into the replacement property to fully defer taxes. If you receive any cash or debt relief that you don't reinvest, that's considered "boot" and will be taxable. In your case, by paying off the $115,000 mortgage before the exchange, you're essentially changing your equity position in the property. When you then do the exchange, you'll need to make sure you take on at least the same amount of debt in your replacement property (or add more cash to compensate). Otherwise, the IRS could view it as receiving debt relief during the exchange, which would be taxable boot. The timing of the payoff isn't really the issue - it's making sure that your overall debt and equity positions in the replacement property meet the 1031 requirements. Talk to a qualified intermediary before making any moves!

I used taxr.ai when I was in almost the exact same situation last year. I had a rental property with about $90k left on the mortgage that I wanted to sell in a 1031 exchange, and I had the same question about paying it off first. I was getting conflicting advice from my real estate agent and a friend who's an accountant. I uploaded my mortgage statements and some documents about the potential 1031 exchange to https://taxr.ai and got an analysis that really cleared things up. They explained that paying off the mortgage itself wasn't an issue, but I needed to be careful about the overall debt-equity structure of the replacement property to avoid creating boot. They even ran some numbers on different scenarios based on properties I was considering. Honestly saved me from what could have been a costly mistake because I was about to structure the deal in a way that would have triggered some taxable gain.

Just wanted to follow up on my experience with taxr.ai since I went ahead and tried it after asking about it here. I uploaded my mortgage docs, previous tax returns showing the depreciation I'd taken on my property, and a draft of the 1031 exchange paperwork my agent had given me. The analysis I got back was WAY more detailed than I expected! They actually identified that I had been miscalculating my depreciation for the past 3 years (I was depreciating some personal property items incorrectly) and showed how that would affect my 1031 exchange calculations. On the mortgage payoff question, they confirmed it was fine to pay it off before the exchange but gave me specific numbers for how much debt I'd need to take on with the replacement property to avoid boot. Honestly worth every penny - would've messed up my taxes again without realizing it. Definitely not just generic advice!

Hey all - seeing these mortgage/1031 questions reminded me of my nightmare trying to get clear answers from the IRS on a similar question last year. I spent DAYS trying to get through to someone who actually understood 1031 exchanges. After being on hold for literally 3+ hours and getting disconnected twice, I was ready to give up. Then a colleague told me about Claimyr. It's this service that basically holds your place in line with the IRS and calls you when an agent is about to pick up. I was super skeptical but checked out their demo at https://youtu.be/_kiP6q8DX5c and decided to try https://claimyr.com since I was desperate. No exaggeration - I had an IRS tax specialist on the phone within 45 minutes after weeks of failed attempts. The agent walked me through exactly how mortgage payoffs affect 1031 exchanges and confirmed that pre-paying before the exchange was fine as long as I structured the replacement property correctly. Saved me thousands potentially.

Alright, I need to apologize publicly. After calling BS on that Claimyr service, I decided to try it myself because I've been trying to reach the IRS for WEEKS about my own 1031 question (related to a partial exchange). I'm honestly shocked. It actually worked exactly as described. I signed up, put in my number, and about 35 minutes later got a call connecting me to an IRS agent who was knowledgeable about 1031 exchanges. I didn't have to sit on hold at all - just went about my day until they called. The agent confirmed what others here have said - paying off a mortgage before a 1031 is totally fine, but you need to be careful about the debt structure on the replacement property to avoid boot. If you have equal or greater debt on the new property, or compensate with additional cash, you're good. Sorry for being so cynical before. Sometimes good things actually exist!

Something everyone is missing here about paying off mortgages before a 1031 exchange - make sure you keep documentation proving where that payoff money came from! I did almost exactly what you're planning about 2 years ago, and during an audit, the IRS questioned whether the funds I used to pay off the mortgage actually came from outside sources or if I had secretly received them from the buyer outside of escrow. Had to provide bank statements showing the money trail. Just keep good records showing the mortgage payoff came from your personal funds, not from any arrangement with the buyer. Makes the audit process much smoother if it happens.

Careful about trying to pay off your mortgage right before a 1031! I did this and it backfired. My lender reported the early payoff to credit bureaus which temporarily lowered my score (weird but true). Then when I went to get financing for my replacement property, I got a worse rate because of the score drop.

One thing to consider with mortgage payoffs before a 1031 exchange that nobody's mentioned yet - if your existing mortgage has a prepayment penalty, that penalty is NOT considered part of your exchange basis. I found this out the hard way and ended up with a $3,800 penalty that I couldn't roll into the 1031. Check your mortgage terms carefully!

This is a really thorough discussion! Just wanted to add one more consideration that might be relevant - the timing of when you actually pay off the mortgage versus when you start the 1031 exchange process. I'm dealing with a similar situation right now and my qualified intermediary advised me to coordinate the mortgage payoff timing carefully with the exchange timeline. If you pay off the mortgage too far in advance of listing the property, it could raise questions about your intent to do a 1031 exchange from the beginning. The IRS likes to see that your 1031 exchange was planned as part of an investment strategy, not something you decided to do after the fact. So while paying off the mortgage before the exchange is totally fine from a tax perspective (as others have confirmed), just make sure you can document that the 1031 was always part of your plan. My QI suggested keeping records showing I was researching replacement properties and consulting with them before paying off the mortgage, just to establish the timeline clearly. Probably overkill, but better safe than sorry with the IRS!