What Are 1031 Exchanges?
In real estate transactions, 1031 exchanges refer to the process of swapping one investment property of another for the purposes of deferring capital gains taxes that would otherwise have to be paid. The term comes from the IRS tax code section 1031 and has specific requirements for its use.
In general terms, the section allows investors to exchange only properties that are substantially similar and there are specific rule for doing this with vacation properties. In addition, there are other tax considerations that may apply and requirements relating to the period in which the transaction is completed.
Essentially section 1031 allows the swapping of one investment property for another to limit, or avoid paying altogether, the capital gains tax applicable for the sale. It allows investors to, in effect, defer paying this tax by allowing the investment to continue growing in value.