The IRS Code 1031 is a tool that any commercial real estate owner or investor should familiarize themselves with. There are many rules governing a like-kind exchange. They range from the obvious to the complicated. Some have to do with defining terms, and others have to do with your eligibility. Before you can take advantage of like-kind exchanges, you need to understand some of the rules that come with them. Here are some of the rules you should be aware of.

1. "Like-kind" doesn't mean what you think it means

Many investors assume that like-kind means the property exchange can only occur between the same types of property, or property that serves similar functions. In truth, the term is incredibly flexible. According to 1031 exchange rules, like-kind typically means property that shares a similar nature.

That "nature" for commercial real estate is its function. That means usually, if the exchange is between two investment properties, then they are like-kind because they're investment properties and not personal property.

2. 1031 is for investment property only

You cannot initiate an exchange with a primary residence. The 1031 documentation does not allow personal dwellings. However, even commercial property is ineligible if it's not an investment property.

This is an important sticking point. You cannot purchase (or flip) a property, hold it with the intent to sale, then use it in a like-kind exchange. There is a fine line between holding for resale and holding as an investment, so tread carefully when you're trading your commercial property.

3. You must invest it all or pay taxes on what remains

The whole purpose of a 1031 exchange is to defer taxes. There's an expectation that all proceeds from the exchange will go into the new property. Since you can only exchange for property of equal or greater value than yours, there's a chance this will not come into play.

Unfortunately, real estate isn't always so cut-and-dry. The initial price of the properties can change. You may have mortgage attached to your property. The other property may come with debt. If there's cash left over after the exchange, it's subject to taxation.

4. You MUST use an intermediary

A 1031 exchange is not something you're allowed to do on your own. The IRS requires that you have an intermediary that you're not related to personally or through recent previous business. That intermediary will prepare all the proper documentation and hold the separate properties during the exchange.

In fact, before you do anything, you should speak to a professional intermediary about more of the rules and regulations associated with a 1031 exchange. These exchanges can become very complex, and if you go about it the wrong way, the IRS will not allow the exchange to happen.