IRS Code

• The term "1031 exchange" results from tax laws, specifically, U.S. Code: Title 26,1031. The code states that no gain or loss shall be recognized on the exchange of property as long as it is held for productive use. The intent is to allow people dealing with tangible, real, useful property to defer taxation on their gains. It specifically excludes non-real assets like stocks or other securities.
  
  

Exchange

• As an "exchange," a 1031 exchange involves more than one transaction. The sale of one property cannot take place without the purchase of another. The two must be merged into one transaction that collectively becomes an exchange. Because of this complexity, real estate investors must call upon qualified intermediaries to assist them.
  
  

Qualified Intermediaries

• Qualified Intermediaries (QI) are objective third parties with qualifications recognized by the IRS to handle the complex exchange of property ownership. Retained by the real estate investor seeking a 1031 exchange, they manage the movement of ownership of the relinquished and acquired properties between the taxpayer (real estate investor) and the buyer and seller, respectively, of the two properties involved in the exchange. Since the QI will charge a fee of several hundred dollars or more for its service, the taxpayer must consider this expense versus the value of the deferred tax savings.
  
  

Restrictions

• All equity must be reinvested from the first property to the second, or else the uninvested portion will be taxed. Also, the property must be "like kind," meaning real property for productive use. There are also time restrictions. The taxpayer must identify the second property within 45 days from the day of selling the relinquished property. Then he must also acquire that property within 180 days after relinquishing the first property, or before their taxes are due, whichever date comes first.
  
  

Deferral

• Deferral implies a delay in tax payment, which is the ultimate goal of the 1031 exchange, but it does not allow for the avoidance of taxes. Unless the taxpayer continuously engages in 1031 exchanges, the tax on the gains from each property will come due to the IRS. Deferring payment has advantages since the funds that would otherwise go into tax payments can work for the investor, but to take the gains out of the properties by selling the final property, the taxpayer will have to pay the taxes on all gains.