A 1031 Exchange is becoming more and more common in the world of real estate. A 1031 exchange (also called a like-kind exchange) is a replacement of one business or investment asset for another, which allows you to defer the tax on capital gains until some point in the future.
In effect, you can change the form of your investment (as the IRS sees it) without cashing out or recognizing a capital gain. That allows your investment to continue to grow tax deferred. There’s no limit on how many times or how frequently you can do a 1031 exchange. You can roll over the gain from one piece of investment real estate to another to another and another. Although you may have a profit on each replacement, you avoid tax until you actually sell for cash many years later. Then you’ll hopefully pay only one tax.
A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of “like-kind”, while deferring the payment of federal income taxes and some state taxes on the transaction.
The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer’s investment is still the same, only the form has changed (for example, vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a “paper” gain.
The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.
It’s important you seek professional help when you are considering a 1031 exchange. For more information, get connected with a land consultant , speak to a tax advisor and visit http://www.1031.org/about1031/faq.htm .