When a taxpayer sells property, the taxpayer usually has to pay income tax on the gain realized, typically the difference between the property's adjusted basis and the sale price. Section 1031 of the Internal Revenue Code allows taxpayers to defer the income tax on gain realized when certain property held for investment or productive use in a trade or business is exchanged for property of like kind which is likewise held by the taxpayer for investment or productive use in a trade or business. Real estate is often used in section 1031 exchanges because any given parcel of real estate is almost always considered to be of like kind to any other parcel of real estate regardless of whether such parcels are improved, unimproved, productive or unproductive. Section 1031 specifically prohibits using in a like kind exchange inventory, stocks, bonds, notes, most partnership interests, other securities or evidence of indebtedness among certain other intangible property.

Although section 1031 refers to exchanges, it is not necessary for a taxpayer to find another person willing to directly swap property of like kind in order to obtain the benefits of section 1031. Treasury regulation section 1.1031-1(k) provides methods, safe harbors, for taxpayers to transfer their property (relinquished property) to one party and acquire replacement property with the proceeds from a different third party. In order to preserve the exchange element and prevent taxpayers from merely selling relinquished property and buying replacement property each safe harbor restricts a taxpayer's access to the sales proceeds of the relinquished property during the exchange period by requiring a third party, e.g., qualified intermediary, trustee or escrow agent, to hold the proceeds and disperse same for the replacement property. Indeed, if a taxpayer has access to sales proceeds prematurely, a like kind exchange will be thwarted. Thus, it is imperative that the documentation to effect a like kind exchange be in place prior to closing on the relinquished property. Note, however, that this documentation can be accomplished as late as the day of closing and still qualify under section 1031.

The period of time allowed to effect a deferred like kind exchange is divided into two segments: the first segment requires the taxpayer to identify qualified replacement property within forty-five (45) days after the transfer of the relinquished property (identification period), and the second segment requires the taxpayer to actually acquire the replacement property within one hundred eighty (180) days after the transfer of the relinquished property (exchange period). Note that a taxpayer may identify more than one replacement property, subject to the following limitations: (a) a taxpayer may identify up to three replacement properties regardless of their aggregate fair market value, or (b) more than three replacement properties, but only if their aggregate fair market value does not exceed 200% of the value of the relinquished property.