A smart tax saving tool that is gaining popularity among the real estate investors by enabling them to defer the entire capital gains tax is 1031 Exchange. Established in 1990 by the Internal Revenue Code Section 1.1031, it gives them an opportunity to defer their capital gain taxes on the sale of a property by re-investing the proceeds into “like kind” of property. However, one needs to have complete knowledge of the terms and conditions that apply for 1031 Exchange, and how it works.

Some very basic things that one should understand about 1031 Exchange are that only business and investment property qualify for the tax deferral under Section 1031. Also, the properties involved in the transactions should be of “like kind”. The term “like kind’ has often been misinterpreted to mean that if someone is selling an office of 1200 sq. ft. he should invest the money he gets from its sale to buy an office of 1200 sq. ft. only. However, this is not the case and this term has a very broad meaning. It actually encompasses any real estate held for productive use in a business or for investment. For personal property to qualify it must be depreciable and part of the daily operations of a trade or business, for instance automobiles, office equipment and furniture, machinery, computers, billboards, franchise licenses, and the like. 1031 Exchange does not cover cash, stock in trade or other property held primarily for sale, such as, stocks, bonds, notes or other securities or evidences of indebtedness, partnership interests, and certificates of trust or beneficial interests. The real property to which the rules of 1031 Exchange apply includes raw land, single family homes, hotels, multi-family dwellings, factory and office buildings, shopping centers, farmland, and so on.

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