Do I need a new loan for a 1031 exchange?

Hans Goldstein structures installment sales for sellers and works alongside their CPAs and brokers. Email hans@goldsteinco.net or call 213-414-2808.

Why can't my old loan move to the new property?

Because the loan is secured by the building you are selling, and the note says what happens when you sell it. Nearly every commercial mortgage has a due-on-sale clause: if the property is sold or transferred, the lender can call the whole balance due. The Garn-St Germain Act, 12 U.S.C. §1701j-3 makes those clauses enforceable nationwide and overrides the state laws that once limited them. Its exceptions protect homeowners in narrow situations, such as a transfer of a one-to-four unit residence to a spouse or child. None of them help the owner of an office building, a retail strip or a 20-unit apartment building.

So at closing, escrow pays your lender in full out of the sale price. The lender's collateral is gone, and it has no reason to move the loan onto a building it never underwrote. What reaches your qualified intermediary is the equity: the price, minus the payoff, minus closing costs, minus any prepayment penalty.

Why does the replacement need debt at all?

Because the tax code treats a paid-off loan as if you received cash. Under Treas. Reg. §1.1031(d)-2-2), debt you are relieved of counts as money received unless something offsets it. Two things do: debt you take on with the replacement property, and cash you add from outside the exchange. Whatever relief is left over is boot, and under IRC §1031(b) you are taxed on the lesser of your realized gain or that net boot.

The rule brokers repeat: buy equal or greater in value, reinvest all the equity, and replace the debt. Miss the debt piece and the shortfall is taxable even though you never touched a dollar of it. One more rule worth knowing early: taking on a bigger loan does not cancel cash you take out. New debt offsets old debt. It never offsets cash you pocket.

The full netting rules, with three worked scenarios, are in the 1031 debt replacement rule.

What does that look like on a real deal?

Here is a deal on my desk, rounded. An office building selling for about $4.0M at about a 6.4% cap rate, which is net operating income of about $256,000 ($4,000,000 x 6.4%). The owner bought it for $885,000 in 2019 and took out a $2.1M loan seven months before the sale.

The $2.1M gap has to come from somewhere. Illustrative ways to fill it:

The arithmetic in the last two rows: $2,100,000 of debt relieved minus $1,500,000 of new debt leaves $600,000 of boot; with no new debt, all $2,100,000 is boot. Because the owner paid $885,000, the realized gain is above $3.1M even before depreciation is added back, so the lesser of gain or boot is the boot. Every dollar of it would be taxable.

Most owners take the first row. That is the point: on this deal, the 1031 hands the seller a $2.1M loan at today's rates. If that loan costs more than the 6.4% the building earns, each borrowed dollar costs more than it brings in. That is negative leverage, and it is the part of the 1031 conversation that usually comes up late.

How does a new loan fit inside the 45 and 180 days?

Tightly. You have 45 days from the day the old property transfers to identify replacements in writing, and 180 days to close on them. The 180 days ends early if your tax return for the year of the sale is due first, extensions included (Treas. Reg. §1.1031(k)-1(b)-1)). Neither clock pauses for a lender.

A commercial loan is a full underwriting: application, tax returns and personal financial statement, rent roll and leases, appraisal, environmental and property condition reports, credit approval, rate lock and loan documents. Timing varies by lender and property, and any one of those steps can slip. A financing contingency in your purchase contract protects your deposit. It does not extend day 180. If the loan does not fund in time, whatever has not closed falls out of the exchange and becomes taxable (see what happens when a 1031 fails).

What works: talk to two or three lenders before you list, get term sheets on the kind of property you plan to buy, and identify backups on day 45 in case a lender says no on the first choice.

Are there ways around a new loan?

A few, and they are the exception:

Each of these still has to close inside the same 45 and 180 days.

What should you check before you list?

1. Read the note. Find the due-on-sale and prepayment sections. A loan seven months old is often in the most expensive year of a step-down penalty or inside a lockout (prepayment penalties when selling).
2. Ask the servicer for a payoff estimate so the equity number is real.
3. Price the replacement debt with lenders before you sign a listing, not after you close.
4. Run the boot math in the 1031 boot calculator for full, partial and no replacement debt.
5. Pick the path before the purchase agreement is signed. Some options only exist if they are written in before closing.

What if you don't want a new loan at all?

Some sellers get to this point and decide they do not want a new lender, a new rate or another building to run. A structured installment sale is one route. The buyer pays in full at closing. Part of the price goes to an assignment company, which takes on the obligation to pay you and funds it with a fixed annuity from an insurer. You report the gain under IRC §453 as the payments arrive. You are not the lender, and the buyer owes you nothing after closing.

The flip side, stated once: your old loan is still paid off at closing, prepayment penalty included, and that payoff is part of what you receive in year one, so it is taxed in year one at the sale's gross profit ratio. Any ordinary depreciation recapture is also taxed in the year of sale either way. What the structure removes is the forced new debt: no new loan, no new rate, no negative leverage, no landlord job. The rest of the gain is reported as payments arrive.

The trade-offs: payments are locked in once set and cannot be accelerated or cashed out. They depend on the assignment company and the insurer behind it. There is no published IRS ruling on this specific structure, so your CPA should review it. A commission of about 4% of the amount structured, paid by the insurer, is built into the pricing. The interest in each payment is ordinary income. It has to be written into the purchase agreement before closing; money already sitting with a qualified intermediary cannot be structured later. Some sellers split it: exchange part, structure the rest (1031 and installment sale together).

Run both paths with your own numbers in the advanced calculator, or send Hans the deal and he will lay them side by side for your CPA.

Frequently asked

Q: Can I keep my existing mortgage in a 1031 exchange? A: Almost never. Commercial loans carry due-on-sale clauses, so the loan is paid off at closing. A lender-approved collateral substitution is possible but rare.

Q: Does the new loan have to equal the old one? A: To defer all the gain, new debt plus any cash you add must be at least the debt paid off. The new loan can be larger, or smaller if you make up the difference with your own cash. Taking on more debt does not offset cash you take out.

Q: Does the interest rate on the new loan matter for the tax rules? A: No. The tax rules count only the amount of debt. The rate is a cash flow question: if it is above the replacement's cap rate, the loan lowers your return.

Q: Does a financing contingency extend my 180 days? A: No. The 45-day and 180-day deadlines are fixed by the regulations. A contingency can protect your deposit, but anything not closed by day 180 falls out of the exchange.

Q: Can a Delaware statutory trust replace my debt without a new loan? A: It can. Your share of the trust's existing loan generally counts as debt on the replacement side. You give up control of the property, the loan and the timing of the sale.

What should you read or run next?

• The 1031 debt replacement rule, with worked scenarios
• 1031 exchanges when rates are high in 2026
• Can you assume a loan in a 1031 exchange?
• 1031 boot calculator
• Advanced calculator: 1031 vs structured sale
• Structured sale as a 1031 backup

Who wrote this?