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

Efficiently, this means that the property investor who usually trades a property investment business for one or more similar properties for investment can defer payment of income tax for the federal government and even defer some state taxes.

This is effective for any asset classified as ‘real property’ as long as it’s used for investment purposes, active use in a trade or business or for the production of income.

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 tax payer is exchanging one investment property for another property or properties or a like-kind then the IRS consider that the person hasn’t received anything that could be used to pay taxes with.

The capital gain has been transferred from one asset to the next, so the IRS doesn’t recognize any gain or loss as being 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 in the future where you do sell the replacement property then you should be aware that you will be taxed on the original capital gain that you deferred plus you’ll also be taxed on the additional gain you may have realized since you first bought that property as well.

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.

The exchanges of shares in the different actions are not eligible. This means that if you sell a stock you need to exchange for more of the same stock to take advantage of Section 1031 Exchange and defer tax on any capital gain you have made.