1031 Exchange Explained

1031 Exchange Explained

A tax-deferred exchange is a method by which a real estate investor trades one or more relinquished rental real estate for one or more replacement rental real estate of like-kind, while deferring the payment of federal income taxes and some state taxes on the transaction. In turn, internal revenue code provides that no gain or loss shall be recognized on the exchange of rental real estate held for productive use in a trade or business. The theory behind internal revenue code is that when a real estate investor has reinvested the sale proceeds into another rental real estate, 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 (e. g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a paper gain.

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