What is a Like-Kind Property?
The concept of like-kind property pertains to two real estate assets of a similar nature—regardless of grade or quality—that can be exchanged without incurring tax liability. Under Section 1031 of the Internal Revenue Code (IRC), like-kind properties include those held for investment, trade, or business purposes, qualifying them for a 1031 exchange. Properties involved must be designated for business or investment, excluding personal residences from being eligible.
Key Insights:
- Tax-Free Exchanging: Like-kind properties are real estate assets that can be traded without tax implications under Section 1031:
- Must be used for business or investment purposes.
- Need not match in grade or quality.
- Excludes primary residences and foreign properties.
Deep Dive into Like-Kind Properties
Businesses and individuals owning qualified business or investment properties can partake in a like-kind exchange. Known as a tax-deferred exchange under Section 1031, it enables sellers to bypass capital gains taxes on exchanges that conform to the IRS’s definitions. Direct sales do not qualify; the properties must be traded in a structured exchange. It’s also imperative that like-kind properties are located within the United States to be eligible.
Securities, stocks, bonds, partnership interests, and other financial assets are excluded from being considered like-kind properties, thus not qualifying for tax deferrals.
Variations of Like-Kind Exchanges
Like-kind exchanges come in different forms:
- Simultaneous Exchange: Properties are exchanged simultaneously on the same day.
- Deferred Exchange: The parties have 180 days to complete the exchange. For instance, if an investor sells farmland, they must identify the replacement property within 45 days and finalize the purchase within 180 days of the initial sale, or the tax return deadline for that year. Extensions may be available.
A common misconception is that like-kind properties must be identical in type or size. However, properties can be disparate in nature as long as they qualify. Primary residences are not eligible. Here are some examples of like-kind property exchanges:
- Multifamily property for an industrial building.
- Vacant land for a medical complex.
- Apartment building for a shopping center.
- Hotel for a retail property.
- Condominium rental for a single-family rental.
Important Considerations
Despite changes to the tax code, real estate transactions under like-kind property exchanges remain significant. Although previously used for various assets including cars, art, and cryptocurrency, these instances have been scaled back. The recent Tax Cuts and Jobs Act restricted like-kind property exchanges to real estate held for business or investment.
The 1031 exchange process is complex, making it advisable to employ a reputable 1031 exchange company instead of hourly legal consultations. These firms offer cost efficiency and reliability, ensuring smooth transactions. While debate continues on the advantageous tax status of real estate over other investments, like-kind property exchanges remain a valuable method for building tax-deferred wealth in real estate as of 2021.
Related Terms: capital gains, Internal Revenue Code, like-kind exchange, tax deferral, investment property.
References
- Internal Revenue Service. “Like-Kind Exchanges—Real Estate Tax Tips”.
- Internal Revenue Service. “Like-Kind Exchanges Under IRC Section 1031”, Pages 2-3.
- Internal Revenue Service. “Like-Kind Exchanges Now Limited to Real Property”.
