A tax-deferred exchange under Section 1031 of the Internal Revenue Code allows investors to defer capital gains taxes on the sale of certain types of property if the proceeds are reinvested in a similar property. For example, an investor might sell a rental property and use the proceeds to acquire a larger apartment complex, deferring the tax liability. This process often involves complex computations to determine the realized gain, the recognized gain (the portion subject to immediate taxation), and the basis of the replacement property.
Deferring capital gains tax can free up significant capital for reinvestment, potentially accelerating wealth accumulation. This provision in the tax code has a long history, stemming from a recognition of the economic benefits of facilitating property exchanges and reinvestment. By allowing taxpayers to defer taxes, it encourages investment in productive assets and promotes economic growth.
