DEFER
TAXES WITH LIKE-KIND EXCHANGES
In a typic=
al
transaction, the property owner is taxed on any gain realized from the sale.
However, through a Section 1031 Exchange, the tax on the gain is deferred u=
ntil
some future date.
Section 10=
31 of
the Internal Revenue Code provides that no gain or loss shall be recognized=
on
the exchange of property held for productive use in a trade or business, or=
for
investment. A tax-deferred exchange is a method by which a property owner t=
rades
one or more relinquished properties for one or more replacement properties =
of
"like-kind", while deferring the payment of federal income taxes =
and
some state taxes on the transaction.
The theory=
behind
Section 1031 is that when a property owner has reinvested the sale proceeds
into another property, the economic gain has not been realized in a way that
generates funds to pay any tax. In other words, the taxpayer's investment is
still the same, only the form has changed (e.g. vacant land exchanged for a=
partment
building). Therefore, it would be unfair to force the taxpayer to pay tax o=
n a
"paper" gain.
The like-k=
ind
exchange under Section 1031 is tax-deferred, not tax-free. When the replace=
ment
property is ultimately sold (not as part of another exchange), the original
deferred gain, plus any additional gain realized since the purchase of the
replacement property, is subject to tax.