We are pleased to share this guest blog provided to our readers by Ray Simmons of Exchange Planning Corporation (https://www.epc1031.com/):
How Often is a 1031 Exchange into a DST reported wrong?
Quick Answer: More often than almost anyone expects. Exchange Planning Corporation reviewed 35 exchanges prepared by other tax professionals and 80% of them needed changes. A second, smaller review — limited to investors in a single DST — produced nearly the same result. Across the full population of exchanges EPC reviews, close to half contain reporting errors that reduce depreciation and raise the investor’s tax bill. The IRS does not check exchanges for accuracy, so an error sits on the return and compounds until someone looks for it.
Does the IRS check whether a 1031 exchange was reported correctly?
No. This is the part that surprises investors most.
Form 8824 goes in with the return and gets accepted. Nothing in the filing process compares the closing statement to the numbers on the form, verifies the carryover basis, or asks whether the depreciation schedule that follows makes sense. The return is accepted, the basis carries forward, and the error travels with the property for as long as the investor owns it — and into the next exchange after that.
That is why Exchange Planning Corporation ran the study. We wanted to know how the tax preparation industry actually performs on exchange reporting when no one is checking. Thirty-five returns is a small sample and we say so plainly. But 80% needing changes was lopsided enough that we sat on the result rather than publishing it. When a second look — a narrower set of investors in one DST — came back nearly identical, it stopped looking like a fluke.
What does a misreported DST exchange actually cost an investor?
Take a composite case built from scenarios we see routinely. Call him Norton.
Norton is a long-time landlord. He held his property for decades, used up most of the depreciation on it, and reached the point where the rental income was producing a tax bill he never planned for. In 2022 he exchanged into three DSTs with roughly $850,000 of equity and no debt.
The exchange itself closed correctly. The return did not. From the exchange through the end of 2025, Norton failed to claim approximately $188,000 in depreciation deductions — about $50,000 in tax he did not owe and paid anyway.
The errors were the ordinary ones. Basis wrong. Closing adjustments treated as taxable income. No shorter-life property broken out. None of it is exotic — just common issues we work on daily. All of it is expensive, because depreciation errors don’t happen once — they repeat every year.
If the mechanics of that are unfamiliar, start with carryover and excess basis explained simply. It’s the concept underneath most of what goes wrong.
Can missed depreciation from a past exchange still be recovered?
Usually, yes — and not by amending old returns.
When depreciation has been understated across two or more years, the IRS treats it as an accounting method, not a mistake. The fix is Form 3115 with a Section 481(a) adjustment, which claims the entire cumulative shortfall in the current year without reopening prior returns. For Norton, that means the missed deductions come back as a catch-up rather than as three separate amendments.
How quickly the tax itself is recovered depends on the investor’s income and passive loss position — for a case like Norton’s it is typically a couple of years, not a single refund check. The same mechanism applies to other basis errors that went unnoticed for years, including a missed step-up in basis on an inherited DST interest.
Why are so many 1031 exchanges reported incorrectly?
Not because tax professionals are careless. The ones we work with are usually the ones who knew they were outside their lane and went looking for help. The structural problem is that the tax preparation industry and the exchange industry grew up separately, and almost nothing connects them.
Investors don’t sell often. Hold periods on rental real estate are measured in decades. A tax professional may see one or two exchanges in an entire career. Without repetition there’s no reason to build depth in carryover basis, excess basis, or replacement-property allocation.
The inputs are the wrong shape. Tax preparation runs on source documents — 1099s, K-1s, brokerage statements. Reporting an exchange correctly starts with reading a closing statement line by line and deciding what each adjustment is. That is a different skill, and most preparers have seen a closing statement maybe twice, both times on their own house.
The software doesn’t help. No commercial tax package will tell a preparer which depreciation method belongs on a post-exchange replacement property. We built our own software for this because nothing on the market does it.
There’s nowhere to ask. Exchange Planning Corporation documents exchanges on behalf of other tax professionals and fields these questions all day — but we reach a few hundred firms out of hundreds of thousands. Most preparers facing an exchange have no specialist to call.
None of that is a competence problem. It’s a specialization gap. Most CPAs we work with are relieved to hand the exchange documentation to a firm that does only this — and to get back a package they can file with confidence.
How do I know if my own exchange was reported wrong?
Pull the depreciation schedule for the replacement property and count the entries. If there’s one line for building and one for land and nothing else, the depreciation is almost certainly being shortchanged.
Then check Form 8824 for the year of the sale. A zero on line 15 often means prorations or security deposits were misreported as taxable income. A blank line 16 understates the replacement price and therefore the cost basis.
Basis problems also surface at the far end of the hold, which is why a property sold at a loss sometimes produces no deduction — the basis was never tracked correctly to begin with.
Those are three of the five checks we recommend running on any past exchange. The full Five Checks guide walks through all of them — no tax expertise required.
If any of that looks off, or if you can’t find the schedule at all, the exchange is worth a second set of eyes. Exchange Planning Corporation reviews past exchanges at no additional charge as a first step. There is no downside to being told the numbers are right.
Frequently Asked Questions
How common are 1031 exchange reporting errors?
In Exchange Planning Corporation’s review of 35 exchanges prepared by other firms, 80% required changes. Across the broader population of exchanges EPC reviews, close to half contain reporting errors affecting basis, depreciation, or the treatment of closing adjustments.
Does the IRS verify that my 1031 exchange was reported correctly?
No. Form 8824 is accepted as filed. Nothing in the process cross-checks it against the closing statement or the depreciation schedule, which is why errors go undetected for years.
Can I fix a 1031 exchange that was reported wrong years ago?
In most cases, yes. When depreciation has been understated for two or more years, the correction is made with Form 3115 and a Section 481(a) adjustment, which claims the cumulative shortfall in the current year without amending prior returns.
Why would my tax preparer get my 1031 exchange wrong?
Exchanges are rare in any one practice, the analysis starts with a closing statement rather than a standard tax form, and commercial tax software offers no guidance on choosing the correct depreciation method. It is a specialization gap, not a competence issue.
How do I know if my DST exchange has a depreciation problem?
Count the entries on your replacement property’s depreciation schedule. Fewer than four — meaning no shorter-life property was separated out — is a strong signal that depreciation is being understated. Exchange Planning Corporation can review the return and confirm.
For more information contact FGG1031 @ info@firstguardiangroup.com
Disclosure: This content is provided for informational and tax-analysis purposes only. It does not constitute investment, financial, or legal advice and should not be relied upon to evaluate any specific investment, including DSTs, real estate offerings, or securities. Exchange Planning Corporation is not a registered investment advisor or broker-dealer. Please consult appropriate licensed professionals for investment recommendations and suitability evaluations.
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