What Is a 1031 Tax Exchange?

What Is a 1031 Tax Exchange?

A 1031 tax exchange provides exceptions and tax deferments for like-kind exchanges, which refer to the process of swapping one business or investment asset for another. The rules and regulations associated with these transactions are outlined under IRC Code Section 1031.

A tax 1031 tax exchange is accomplished following a "like-kind" exchange or simultaneous swap of investment properties. To satisfy these requirements, the properties in question must be of similar nature, character or class and held as an investment or for trade.

The majority of real-estate swaps are regarded as "like-kind," but the cost of the replacement property must at least equal the net proceeds procured from the sale of the original property. Moreover, all of the equity procured from the sale of the relinquished asset must be used to purchase the replacement asset.

The 1031 tax exchange is applied only to business and investment properties; proceeds generated from the sale of a primary residence or vacation home are not subject to the provision. Individuals, corporations, partnerships, trusts, LLCs and all other tax-paying entities are eligible to participate in a 1031 tax exchange.

IRC Section 1031 provides a tax deferment if the gains procured from the sale of a business or investment property are reinvested in a similar property. The 1031 tax exchange thus allows business and investment property owners to postpone the capital gains tax applied to the sale of their investment.