There are certain rules that must be followed while carrying out the exchange under Section 1031 of IRS. The first and the most important rule is that the assets that are going to be exchanged must be of “like kind.” Secondly, the sales proceeds of a like-kind asset must be invested within 180 days of the sale, and the like-kind property where the proceeds have to be reinvested must be identified within forty-five days of the sale. It must be noted here that the IRS is very strict in allowing extensions of this time limit, so one must be prepared well in advance.

Under the existing law, the IRS has classified real estate into four categories: personal property (property held for personal use), dealer property (property held for sale), investment property (property held for investment) and business property (property held for productive use in business or trade). The last two types –investment and business property—qualify for tax deferral under Section 1031, the first two—personal and dealer property—do not qualify for tax deferral under Section 1031.

Legally, what the other party does with the property exchanged would not affect your tax status. There are certain other legal provisions that need to be explained in the context of like-kind property. Under Section 1031, like kind refers mainly to the use of the property. It is not concerned with the grade of the property. Only those properties that are held inside the U.S. and its territories qualify for exchange. No property held outside the U.S. or its territories would qualify for exchange under Section 1031.

One must remember that 1031 Exchange should not be viewed and utilized as a tax loophole because this section of the Internal Revenue Code has been written by Congress. The aim of this provision is to allow people to sell their properties and defer payment of taxes on the gains arising from such transactions.