Internal Revenue Tax Code Section 1031 allows taxpayers to defer income tax on capital gain realized (typically on the difference between the property's adjusted basis and the sale price) from sale of investment property ("relinquished property") which is held by the taxpayer for investment or productive use in a trade or business by reinvesting the proceeds in another property of like kind ("replacement property"). A 1031 exchange is possible only when you sell real estate held for investment purposes. It cannot be used for the sale of your personal residence. Consult IRS rules for the definition of like kind and what types of properties qualify as like kind.

In order to preserve the exchange element and prevent taxpayers from merely selling relinquished property and buying replacement property, a taxpayer's access to the sales proceeds is restricted during the exchange period by requiring a third party (qualified intermediary, trustee or escrow agent) to hold the proceeds and disperse the same for the replacement property. At closing, proceeds are transferred to the third party acting as a facilitator to hold the funds until they are used to acquire the new property. The seller is allowed up to 45 days from such sale to identify the like-kind property where sales proceeds are to be applied