Section 1031 of the tax code provides for the deferral of capital gains and depreciation recapture taxes in which would ordinarily arise from the sale of real estate. Exchanging defers the recognition of the capital gains tax, leaving the property owner with substantially more proceeds to purchase a replacement property.
Section 1031 of the tax code states, "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment purposes if such property is exchanged solely for property of like-kind, which is to be held for other productive use in trade or business or for investment purposes." Real Estate investors can accomplish many investment objectives with 1031 exchanges, including greater leverage, diversification, improved cash flow, geographic relocation, and/or property consolidation. In the Tax Reform Act of 1984, Congress addressed the IRS's continued displeasure with the Starker decision by amending Section 1031 to allow Delayed Exchanges; but only if all of the exchange property is identified and acquired within specific deadlines. And most important in the Conference Report accompanying the 1984 Act, Congress specifically reaffirmed that a "sale" followed by reinvestment in like-kind property doesn't qualify for tax deferral under Section 1031. So to qualify for tax deferral, it is still essential to cautiously structure an exchange to avoid actual or constructive "receipt" of proceeds of sale and to prevent characterization of the transaction as a taxable sale and reinvestment.
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What is a 1031 Tax Exchange?
