A 1031 exchange derives it’s name from Section 1031 of the U.S. Internal Revenue Service Code that allows investors to defer capital gains taxes on any exchange of like-kind properties for business or investment purposes.
Taxes on capital gains are not charged on the sale of a property if the money is being used to purchase another property – the payment of tax is deferred until property is sold with no re-investment.
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 is being held.