A tax deferred exchange is simply a method by which a property owner trades one property for another without having to pay federal income taxes on the transaction. In an ordinary sale transaction, the property owner is taxed on any gain realized by the sale of the property. But in an exchange, the tax on the transaction is deferred until some time in the future, usually when the newly acquired property is sold.
In an exchange, a property owner disposes of one property and acquires another property. The transaction must be structured in such a way that it is in fact an exchange of one property for another, rather than the taxable sale of one property and the purchase of another.
Tax deferred exchanges are authorized by Section 1031 of the Internal Revenue Code. The requirements of Section 1031 must be carefully met, but when an exchange is done properly, the tax on the transaction may be deferred.