A 1031 tax-deferred exchange is a process in which property is treated as a trade, or “exchanged”, for other property, thus deferring taxation on the profit until later. The net proceeds from the sale are escrowed with a Qualified Intermediary (Q.I.) and then disbursed at the exchange closing when the exchange property is purchased.
The Q.I. is crucial: If the sale proceeds come in contact with the seller the exchange is off. In addition, there are time limits to locating the exchange property and closing the sale.
1031 exchanges offer the opportunity to defer capital gains taxes. When an investor pays capital gains they not only write a check to the IRS but lose the use of those dollars for the rest of their lives. By using 1031 exchanges investors can grow their wealth through the power of compounding. For estate planning purposes there is an automatic step-up when the properties go to their estate and the capital gains tax is forgiven.