Just what is a 1031? We'll try to explain without quoting all the IRS rules or sounding like an IRS auditor.
Section 1031 defers capital gains taxes essentially by shifting tax basis from a property sold to an acquired property of “like kind.” For the purpose of Section 1031, the IRS treats any sort of real estate held for investment purposes as being of "like kind" to any other investment real estate. To qualify, property must be used in trade or business or held for investment. A vacation home held for personal use does not qualify. But a vacation home rental property does. And no, you can't use the rental property for personal use, at least not more than more than 14 days a year, or ten percent of annual total rented days. If you do it does not qualify.
Exchange transactions must conform to strict IRS rules, so don't rely solely only on the information we have provided here. There is IRS guidance and clarification on the role of QIs in such transactions. A QI is a "qualifying intermediary". That means he or she is a disinterested, independent party. All exchange transfers must be handled through a QI.
There are timing issues as well. Property to be acquired by the taxpayer must be identified within 45 days of the transfer of the property being sold in the exchange. The entire transaction must be completed within 180 days.
If you are thinking of investing in rental properties, consider whether a 1031 exchange could provide you tax benefits.
