In the 1031 exchange industry, a fully taxable exchange refers to a situation where an investor disposes of a property without following the rules that would allow for a tax-deferred exchange under Section 1031 of the U.S. Internal Revenue Code.
The primary purpose of a 1031 exchange, also known as a like-kind exchange, is to allow investors to defer capital gains taxes that would otherwise be incurred upon the sale of an investment property. This is done by reinvesting the proceeds from the sale of the initial property (relinquished property) into a new property (replacement property) of like-kind, within a certain period of time, and meeting other specific requirements.
However, if an investor does not comply with these rules, such as not meeting the timeline or the like-kind requirement, the exchange will be considered fully taxable. This means that the investor will have to pay capital gains tax on the full amount of the profit from the sale of the relinquished property.