When an owner of investment real property sells the property, the sale often creates an obligation for payment of capital gains taxes. Section 1031 of the Internal Revenue Code of 1986 allows a taxpayer to sell investment real property, have the proceeds used to purchase new investment real property, and defer the taxes on the sale.
A taxpayer may not simply sell relinquished property and use the money to purchase replacement property. The IRS and the Treasury Department have very strict requirements which must be satisfied in order for a taxpayer to qualify for deferred exchange treatment.
To qualify for a deferred exchange, the taxpayer must enter into a valid exchange agreement with a third party. The third party must hold the funds from the sale of the relinquished property and the taxpayer and the third party must comply with the requirements of the regulations.
The regulations allow the taxpayer and third party to place the funds from the sale of the relinquished property into an escrow account.