Legal Definitions - tax-deferred exchange

Tax-deferred exchange is a process where investors and organizations can replace one investment with a similar one instead of keeping the proceeds. This exchange allows the investor or organization to defer capital gains taxes until the new investment is sold for the proceeds. The exchange is called a 1031 exchange and is governed by section 1031 of the Federal tax code.

Let's say an investor owns a rental property that has appreciated in value. If the investor sells the property, they will have to pay capital gains taxes on the profit. However, if the investor uses a tax-deferred exchange, they can sell the rental property and use the proceeds to buy another rental property without paying capital gains taxes. The new property must be of equal or greater value than the original property, and the exchange must be completed within 180 days.

Another example is a business owner who wants to sell their business and use the proceeds to buy another business. By using a tax-deferred exchange, the business owner can defer paying capital gains taxes on the sale of their business until they sell the new business.

These examples illustrate how tax-deferred exchanges can be beneficial for investors and organizations who want to defer paying capital gains taxes and reinvest their profits into similar investments.