Put broadly, a 1031 exchange is a swap of one property for another. This is done between people with investment properties because of a wish to move, for example, without having to go through a traditional buying/selling process.
Most property swaps will be taxed as sales, although you may not have to pay any taxes (or could have the taxes on the sale reduced) if you can meet the 1031 requirements, helping you save money on the exchange overall.
The Internal Revenue Service’s section 1031 allows the swap of properties held for business or investment purposes, and they must be considered like-kind for you to be able to defer capital gains. If you can do this correctly, then you could potentially swap your properties perpetually with no limitations.
Very rarely, you may be able to have a former primary residence count under 1031 requirements, but that’s difficult. If you plan to do this, then that is something to discuss with your attorney as you prepare.
Why would you want to use the 1031 exchange method?
With this exchange, you can essentially allow your investment to continue to grow while tax-deferred. You may see a profit on each swap, but in the end, you’ll only pay taxes if you sell one of those properties for cash in the future. At that point, you will pay the long-term capital gains rate, unless there are other factors that play a role in your case.
Our website has more on 1031 exchanges and what you should know if you would like to exchange properties with someone else locally or in a different area.