What Are They?

1031 Exchanges are one of the best tricks in the book for long-term hold real estate investors and notably a strategy that can turn amateurs into pros. Here's the definition from investopedia:

"A 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred. The term—which gets its name from section 1031 of the Internal Revenue Code (IRC)- is bandied about by real estate agents, title companies, investors, and more. Some people even insist on making it into a verb, as in, “Let’s 1031 that building for another.”

The strategy involves deferring capital gains from a property slated for sale by transferring them into another property, typically of larger size, thus avoiding immediate tax payment on the previous gains. Here's a simplified scenario:

Let's say you own five single-family houses, each bought for $100K and now valued at $200K. You're weary of managing these properties and prefer something less demanding. If you were to sell all five, you'd face a capital gain of $500K subject to a 20% tax ($100K).

Instead of paying this tax, you can exchange the properties for another 'like-kind' property, meeting your new criteria of being less burdensome to manage, and defer the tax until you sell the next property. Essentially, this provides $100K to invest in the new property without immediate tax obligations.

This strategy becomes particularly advantageous if you retain the new property indefinitely or exchange it again in the future.