Understanding Section 1031 Tax-deferred Exchange

Every individual who wishes to take full advantage of the benefits of Section 1031 Exchange must understand that each transaction is different. Although there are rules and procedures that apply to everyone in general, successfully accomplishing one's investment objectives entails exercising due diligence and consulting the right professionals for some much needed legal and fiscal advice.

Unlike regular transactions where a property owner is taxed on gains earned from sales, tax on a Section 1031 Exchange gain is deferred. This is possible because the Internal Revenue Code's Section 1031 states that an exchange of property that is held for trade, business, or investment purposes recognizes neither gains nor losses. Theoretically, a taxpayer's investment did not change in any other way other than its form, so it would only be fair for him or her not to be obligated to pay tax.

This should not mean, however, that a Section 1031 exchange is tax-free. It is only tax-deferred and when the time comes for the replacement property to be sold, the gain from the original transaction, in addition to any other gain realized since the replacement property was purchased, will be subjected to tax just like every other form of transaction.