As defined in Section 1031 of the Internal Revenue Code of 1986, as amended,

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."

A properly structured 1031 exchange allows an investor to sell an investment opportunity and defer all capital gains taxes provided they reinvest the proceeds in a new investment opportunity within a clearly defined time frame.

You can defer all capital gain on your transaction by doing all of the following:

• purchasing investment opportunities that are equal to or greater in value than your relinquished property;
• reinvesting all of the net equity from your relinquished property in the replacement investment opportunity; and
• acquiring debt on the replacement investment opportunity that is equal to or greater than the debt on your relinquished property (debt on the replacement property may be offset by contributing an equivalent amount of additional cash)

You can also complete a partial exchange, but this will incur tax liability on the non-qualifying portion.

The investor (Exchanger) must sell property that is held for income or investment purposes and acquire "like-kind" replacement property that will be held for income or investment purposes. The term "like-kind" is sometimes misinterpreted to mean "identical" - but this is not the case. In fact any investment opportunity can generally be exchanged for other investment opportunities.

Examples of qualifying exchange properties include:

• Bare land exchanged for Rental property
• A single family rental exchanged for Industrial property
• A doctor's own office in exchanged for another business opportunity
• Income property exchanged for a Tenancy-In-Common (TIC) interest in a winery

As you can see, there are really few limitations on what constitutes "like kind".

Some examples of properties which do not qualify for exchange purposes include:

• Bonds, Stocks (including REITs), and Notes
• Interests in a Partnership
• Trust Deeds
• Stock in Trade (including Real Estate held as Stock in Trade)

Identification Period: The Exchanger must identify the Replacement Property within 45 days of the transfer of the Relinquished Property. The Exchanger can identify more than one possible Replacement property using one of three options:

1. The three property rule - You may identify up to three replacement investment opportunities regardless of their fair market value. It is not necessary to purchase all of the identified opportunities. (Even if you intend to buy only one replacement opportunity, it is advisable to identify one or two alternate opportunity in case the first opportunity purchase falls through.) This is the most common rule utilized.  

2. The 200% rule - If more than three opportunities are identified, their combined fair market values cannot exceed twice the fair market value of the property being disposed of.  

3. The 95% exception - If more than three opportunities have been identified, and their total fair market value exceeds 200% of the value of what was sold, the exchange may still be valid if 95 % of the total cost of all opportunities on the list are purchased. This means that if the opportunities on your list have a total combined cost of (for example) $1,000,000, then you must purchase at least $950,000 of them.

Exchange Period: The Exchanger must complete the 1031 exchange transaction, which includes the receipt of title to all of their intended replacement properties, by the earlier of:

(a) the 180th calendar day after the Exchanger has transferred title to his or her first relinquished property to the buyer, OR

(b) the due date of the Exchanger's Federal income tax return for the tax year in which the relinquished property was sold, including extensions of time to file.

Exchangers do not have to worry about part (b) above unless their first relinquished property transaction closes on or after October 17th of any given tax year. Exchangers that have 1031 exchange transactions closing on or after October 17th will have fewer than 180 calendar days to complete their 1031 exchange transaction, unless they file for an extension of time to file their federal and, as necessary, state income tax returns. Once the extensions of time have been filed, the Exchanger must complete their 1031 exchange transaction within the 180 calendar days before they actually file their Federal and, if applicable, state income tax returns.

The Exchange Deadline Tool can help you determine your 45 and 180 day expirations.