What is the purpose of a 1031 exchange?
A 1031 tax deferred exchange allows you to roll-over all of the proceeds received from the sale of an investment property into the purchase of one or more other like-kind investment properties. At closing, proceeds are transferred to a third-party–called a facilitator or qualified intermediary–who holds them until they are used acquire the new property.
Exchanges Allow You to Delay Capital Gains Taxes
Capital gains taxes are deferred if all of the exchange funds are used to purchase like-kind investment property. The deferment is like getting an interest-free loan on the tax dollars you would have owed for a cash sale. More equity is retained, and that helps you move into properties of higher value each time you perform a 1031 exchange.
A 1031 exchange is possible when you sell real estate held for investment purposes. It cannot be used for the sale of your personal residence.
Like Kind Properties
Exchanged properties must be like kind. For a real estate exchange this means real-property for real-property, but not necessarily land for land or a rental house for another rental house. Take a look at the IRS rules for specific information about what types of properties qualify as like kind.
You can exchange a single property for multiple properties, or purchase one property from the proceeds of several. Proceeds not used to purchase new investment property are taxed as a cash sale.
“In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business.” -IRS
Resources for 1031 Exchanges
Like-Kind Exchanges – Real Estate Tax Tips from the IRS
Publication 544, Sales and Other Dispositions of Assets
Form 8824, Like-Kind Exchanges (PDF)