The IRS defines a 1031 exchange from their website:  Click here

Here is a layman's definition:

The 1031 exchange process is an IRS approved way of indefinitely deferring 100% of the capital gains taxes on the sale of qualified investment properties.

It's a powerful tool for investors.  Investors get to take the money they were going to pay in capital gains taxes and reinvest it into other investment property(ies).  They can also use the 1031 process to move their investments in and out of geographical areas and/or different types of properties.  Contact The Private Exchange Group, Inc. for more strategies.

There are multiple reasons. Here are some of the more popular reasons:

1. Move from non cash flowing properties to cash flow.
   
   Example: I own land and I want single family rentals. That way I will now have a monthly cash flow.
2. Move from multiple properties to a single higher producing property.
   
   Example: I own 5 single family rentals all over the city and I'd rather have a single apartment building with more units, more cash flow and only one property to manage.
3. Pass on a substantial income producing real estate portfolio to your heirs while keeping the income in tact.
   
   Example:I am 80 years old and my portfolio is producing enough money to support my heirs in their current lifestyle.  I'm going to exchange several properties to strengthen the portfolio for them and my tax advisor has shown me how to set up my heirs to get a step up in basis* so that the capital gains tax deferral can be preserved.
   *Please ask you tax advisor about this
   
   

The quick answer is just about any. The real test is how you use the property and report it on your taxes.

Here is what the IRS says as taken from their website:

"Both the relinquished property you sell and the replacement property you buy must meet certain requirements.

Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.

Both properties must be similar enough to qualify as "like-kind." Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.

Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. As an example, cars are not like-kind to trucks.

Finally, certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:

1. Inventory or stock in trade
2. Stocks, bonds, or notes
3. Other securities or debt
4. Partnership interests
5. Certificates of trust"

In concept, the process is very simple.  Let's look at some of the steps:

1. The investor decides to sell a qualified investment property because they want to buy other investment property (ies).
   
   
2. The investor or their representative hires a Qualified Intermediary/QI/Exchange Service Company/Accomodator before they close the sale.
   
   
3. The investor and their team sell the property and go about finding the replacement(s). They add the 1031 language to the contracts. Everything about the real estate transactions goes as normal.
   
   
4. The Qualified Intermediary handles all the required paperwork, escrows the money from the sale, and sends the money when the purchase is ready for closing.

Here are some of the basics. For more detail, please contact us to discuss a specific situation as the rules can get too complicated and can actually be more confusing than necessary.

1. The QI has to be hired BEFORE any real estate closings.
   
2. The investor can not touch or have "Constructive Receipt" of the proceeds from the sale. For 100% deferral 100% of the proceeds have to be put in the QI's escrow account. An investor's attorney, CPA, RE Brokers account do not qualify.

3. The real estate investor must invest the total net sales price of the sale into the purchase. This includes all mortgages.

4. The investor must execute all exchange documents at all closings.

5. The investor has exactly 180 days from the close of the sale to complete all purchases. There are no exceptions or extensions. If the 180th day falls on July 4th, the closing must take place sometime before then.

6. The investor has exactly 45 days from the close of the sale to identify up to 3 replacement properties. The list has to be submitted to the QI by midnight of the 45th day. No exceptions.

7. The investor has to file Form 8824 with their tax return for the year that the transaction happened. If you did an exchange in 2008, the 8824 form will be filed with your 2008 tax return.

8. You can do a direct swap with a buyer. This is called a simultaneous exchange. However, you do not have to. When you decide to do an exchange, you do not have to find a buyer to exchange with you. In fact, the buyer does not even have to do an exchange.