Tax-Free Exchange (1031 Exchange)
A Tax-Free Exchange, commonly referred to as a 1031 Exchange, is a provision under Section 1031 of the Internal Revenue Code that allows an investor to defer paying capital gains taxes on an investment property when it is sold, as long as another property of equal or greater value is purchased with the profit gained by the sale.
This exchange must meet specific requirements, such as identifying a replacement property within 45 days and closing on it within 180 days of the sale of the original property. The properties involved must be held for investment or business purposes, and personal residences do not qualify.
For example, if an investor sells a rental property for $500,000 and uses the proceeds to purchase another rental property for $600,000, they may defer the capital gains tax on the $100,000 gain from the sale, provided all requirements of the 1031 Exchange are met.
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