Like-Kind Exchange: U.S. Tax Code Section 1031
This kind of transaction is also called a “1031 exchange,” because Internal Revenue Code section 1031 of the U.S. Internal Revenue Code allows owners of certain kinds of assets to defer capital gains taxes on any exchange of like-kind properties. Both the relinquished property and the acquired property must be like-kind, and must be held for business or investment purposes. Taxes on capital gains are not charged upon sale of a property if a qualifying replacement property is acquired. The transaction has to be properly structured, including that the taxpayer cannot be deemed to have actually or constructively received the sales price of the relinquished property. To avoid "constructive receipt" of the sales proceeds, a neutral party is often used to maintain the sales proceeds out of the reach of the taxpayer. The replacement property generally must be "identified" within 45 days of when the original property is transferred, and must be "acquired" within 180 days of when the original property is transferred. If the transaction is handled properly, the payment of tax is deferred until the replacement property is later sold with no reinvestment in a qualifying property.
The idea behind this section of the tax code is that when an individual or a business sells a property to buy another, no economic gain has been achieved. There has simply been a transfer from one property to another. For example, if a real estate investor sells an apartment building to buy another one, he or she will not be charged tax on any gains he or she made on the original apartment building. When the investor sells the original apartment building and purchases a new one, the value used from the original to buy the new one has not changed – the only thing that has changed is where the value resides.
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