A 1031 exchange (or "like kind exchange") is a transaction under United States law which specifies that if an asset ( in this case, commercial real estate such as land or a building) is sold and the proceeds of the sale are then reinvested in a like kind asset then no gain or loss is recognized, allowing the deferment of capital gains taxes.  This law is defined by section 1031 of the Internal Revenue Code.  See below for the rules that apply to 1031 Exchanges. 

In order to qualify for this exchange, certain rules must be followed:

   1:  Both the relinquished property and the replacement property must be held for investment or for productive use in a trade or business.

   2:  The asset must be of like kind.  Real property must be exchanged for real property.  Personal property must be exchanged for personal property.

   3:  The proceeds of the sale must be invested in a like kind asset within 180 days of the sale.  However, the property must be identified within 45 days.

Frequently, the most difficult component of a 1031 is identifying a replacement property within the first 45 days following the sale of the relinquished property.  The IRS is strict in not allowing extensions.

A 1031 exchange is similar to a traditional IRA or 401K retirement plan.  When someone sells assets in tax-defered retirement plans, the capital gains that would otherwise be taxable are defered until they begin to cash out of the retirement plan.  The same principal holds true for tax-deferred exchanges or real estate investments.  As long as the money continues to be re-invested in other real estate, the capital gains taxes can be deferred.  Unlike the aforementioned retirement accounts, rental income on real estate investments will continue to be taxed as net income is realized.