A deferred exchange, often referred to as a 1031 exchange or a like-kind exchange, is a tax-deferred transaction that allows property owners to replace a property with another “like-kind” property while deferring the payment of federal income taxes and some state taxes on the transaction. This type of exchange is permitted under section 1031 of the U.S. Internal Revenue Code, hence its name.
In a typical 1031 deferred exchange, an individual or company sells a property and then uses the proceeds to purchase another property of a like-kind. Both the sale of the old property and the acquisition of the replacement property are part of the same transaction. In the meantime, the proceeds from the sale are held by a qualified intermediary and not received by the seller.
To fully defer tax on the exchange, the replacement property should be of equal or greater value, and all the proceeds from the relinquished property must be used to acquire the replacement property. The taxpayer has 45 days from the date of the sale of the old property to identify potential replacement properties, and 180 days in total to complete the purchase of the new property.
The primary advantage of a deferred exchange is the deferral of taxes. This allows more of the proceeds from the sale to be reinvested in the next property, which could result in a higher potential for compound growth.