Section 1031 of the Internal Revenue Code allows an owner to exchange one property for another and defer payment of state and federal capital gain taxes. Both properties are to be of “like kind,” meaning, the properties must be either held for productive use in a trade or business or held for an investment.
This allows property owners the ability to realize their investment objectives. By exchanging instead of selling for cash, owners can diversify or consolidate holdings, reduce management commitments, or improve cash flow.
Section 1031 allows continued deferral of taxes on subsequent exchanges, which enables the owner to increase equity without the burden of capital gain taxes. A 1031 exchange is basically the sale of one property followed by the purchase of another.
A 1031 exchange is rarely a simultaneous two party swap. First, a property is sold by the Exchanger to any Buyer. A qualified intermediary must be retained prior to this closing. The exchange funds are held safely in the qualified intermediary’s exchange account and the Exchanger cannot be in receipt of funds at any time during the exchange.
Next, the Exchanger has 6 months to acquire a replacement property and must identify replacement properties within the first 45 days. The final step is the acquisition and closing of the like kind replacement property, which can be closed at any time during the 6 month period.
Here are some additional links for Buyers.