Investors can defer taxes that would have been payable on capital gains at a later date by utilizing a Section 1031 Exchange.

Effectively this means that a property investor who trades an investment property for one or more similar properties for investment use can then defer the payment of income taxes to the federal government and even defer some state taxes.

This is valuable for all assets classified as “property” as it is used for investment purposes, the active use in a trade or business or for income generation.

The logic behind the IRS allows investors to use the Exchange 1031 is that the investor has sold a property and then reinvest the sale proceeds to purchase a new property. The investor never received the proceeds of the sale in a form that allows the funds, so that the IRS do not classify gains as taxable income.

Section 1031 Exchange put simply means that as long as the taxpayer exchange an investment property for another property or properties or the same type, then the IRS consider the person has not received anything that could be used to pay taxes with.

The capital gain was transferred from one asset to another, so that the IRS does not recognize any gain or loss as part of your taxable income.

Please do not make the mistake of judgment that the Exchange 1031 means the same thing as “tax free”. The fact remains that the tax that you paid is deferred until you finally sell the property you have purchased as replacement for the first investment you sold.

At the point where, in the future you sell the replacement property, you should be aware that you will be taxed on the capital gain that you deferred, plus you may also be taxed on the additional gain that you made since you purchased the property.

Of course, if you decide never to sell then you can effectively continue to defer any tax that would have been payable on the original capital gain for as long as you retain ownership.

Exchanging shares of corporate stock in different companies doesn’t qualify. This means that if you sell one stock you’ll need to exchange it for more of the same stock to take advantage of the Section 1031 Exchange and defer the tax on any capital gain you might have realized.