Can a taxpayer do a 1031 exchange of real estate and use the sales proceeds to pay down or pay off a current investment property mortgage?
1031 Exchange Rule #1
First and foremost, in a 1031 exchange the taxpayer conducting the transaction needs to relinquish an old property and receive a new like-kind replacement property. If the taxpayer uses the proceeds from the disposition of the old relinquished property for anything other than the purchase of new replacement property then the exchange may fail.
Paying Off Debt
Paying off debt on land that you already own is not (in the eyes of the IRS) a valid use of the exchange funds. They do not view the receipt of this debt relief as being a replacement property. Bottom line, you need to move your exchange proceeds into your new property. Using these funds for any other purpose – such as paying off a mortgage – will jeopardize your 1031 exchange.