1031 Exchange

1031 Exchange, also known as a Like Kind Exchange or Starker Tax Deferred Exchange (named for an investor who challenged and won a case against the IRS) is a transaction under United States law which specifies under section 1031 of the Internal Revenue Code, 26 U.S.C. § 1031the following:

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."
This allows taxpayers to defer all of the capital gains taxes resulting from the sale of investment property, when they use a Qualified Intermediary, follow the IRS guidelines, and use the proceeds of the sale to buy more investment property within 180 days of their sale. In order to obtain full benefit, the replacement property must be of equal or greater value, with equal or greater debt, unless the taxpayer adds cash to the deal to replace debt instead, and all of the proceeds from the relinquished property must be used to acquire the replacement property. The taxpayer must have assigned his interest in the relinquished property to a Qualified Intermediary prior to the close of the sale, so that the taxpayer has lost control of the funds before he has any opportunity to obtain them.

At the close of the relinquished property sale, the proceeds are sent by the closing agent to the Qualified Intermediary, who holds the funds until such time as the transaction pertaining to the replacement property is ready to close. Then the proceeds from the sale of the relinquished property are deposited by the Qualified Intermediary to purchase the replacement property, which is then delivered to the taxpayer, all without the taxpayer ever having "constructive receipt" of the funds.

The prevailing idea behind 1031 Exchange is that since the taxpayer is merely exchanging one property for another property(ies) of “like-kind” there is nothing received by the taxpayer that can be used to pay taxes with. All the gain is still locked up in real estate and so no gain or loss can be claimed.