Normally, when you sell an investment property, you owe capital gains taxes, both Federal and State.  The mere fact that you purchase replacement property with the proceeds does nothing to alleviate the taxes.

If you properly structure the transactions as a 1031 Exchange, you retain purchase power of the  24% of your proceeds (approximately) you would have lost to taxes, for the purchase more and/or better replacement property.

The tax deferred exchange, as defined in Section 1031 of the Internal Revenue Code of 1986, as amended, offers investors one of the last great opportunities to build wealth and save taxes. By completing an exchange, the investor (Exchanger) can dispose of their investment property, use all of the equity to acquire replacement investment property, defer the capital gain tax that would ordinarily be paid and leverage all of their equity into a replacement property. Other than the timing requirements for the identification and closing of replacement property, the two major requirements that must be met in order to defer the capital gain tax are: (a) the Exchanger must acquire “like kind” replacement property and (b) the Exchanger cannot receive cash or other benefits (unless the Exchanger pays capital gain taxes on this money).

In the words of the Tax Code: "No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."

The replacement property must be "like-kind", which only means it must be a property you will hold for investment or for use in a trade or business.  It can therefore be of any type of U.S. real property (Commercial, Residential, Industrial, Vacant Land, Agricultural, etc.) as long as the taxpayer will hold the property for “Productive use in a Trade or Business” or “Hold the property for investment.” For example, an owner of a office building in Florida can exchange for a parcel of vacant land in Utah. Later that same taxpayer can exchange the land for a warehouse in Missouri. Later the warehouse can be exchanged into an undivided partial interest in an office tower in Chicago. Later the partial ownership of the office tower can be exchanged for total ownership of a local office building, which will be occupied in part by the taxpayer’s sole proprietorship, the rest being leased for income. These are just some of the scenarios made possible by the enactment of IRC § 1031. This is HUGE!

The table below gives a simplified example of the benefit of using a 1031 Exchange. We compare two identical sales of investment property, side by side.