“Like-kind” Properties: Understanding the Rules and Examples

While Section 1031 of the Internal Revenue Code allows taxpayers to indefinitely defer tax liability on the sale of certain assets, it only applies when a taxpayer exchanges one “like-kind” property for another. As a result, before claiming the benefits of a 1031 exchange, it is critical to ensure that the properties involved qualify. A 1031 exchange facilitator can help—and engaging an experienced facilitator is one of the first steps toward confidently executing a like-kind exchange.

What is a “Like-Kind” Property?

So, what is a “like-kind” property? To begin, we can look at Section 1031 itself. This provision of the Internal Revenue Code states:

“No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.”

Section 1031 then goes on to establish certain exceptions and outline additional requirements for securing tax deferral through a like-kind exchange. As you can see, 1031 limits like-kind exchanges to transactions involving property “held for productive use in a trade or business or for investment.” While Section 1031 doesn’t tell us much else, the Internal Revenue Service (IRS) has provided some additional details on the types of property that can qualify as “like-kind”:

• Real Estate – Under the Tax Cuts and Jobs Act, Section 1031 only applies to exchanges of real property. “[E]ffective January 1, 2018, exchanges of machinery, equipment, vehicles, artwork, collectibles, patents and other intellectual property and intangible business assets generally do not qualify for . . . like-kind exchanges.”
• Nature or Character – Properties will be considered of like kind if they are “of the same nature or character, even if they differ in grade or quality.” Thus, if you are exchanging an old, run-down residential investment property for a new luxury dwelling, Section 1031 still applies.
• Improvements – Section 1031 also applies regardless of whether the existing and replacement properties are improved or unimproved. The IRS provides the example that “an apartment building would generally be like-kind to another apartment building” regardless of the properties’ respective quality, condition, and rental rates.
• Location – Regardless of properties’ nature, character and improvements (if any), they will not be considered “like-kind” if one is located in the United States and the other is located in a different country.

Despite these seeming limitations, Section 1031 is extremely broad. With only very limited exceptions, virtually all real estate held for business or investment purposes can qualify as “like-kind” with any other real estate to be acquired for business or investment purposes (as long as both properties are in the United States). Vacant land can be exchanged for improved real estate, retail properties can be exchanged for residential properties, apartment buildings can be exchanged for condominiums—and these are just a few examples of numerous possibilities.

What Doesn’t Qualify as a “Like-Kind” Property?

Given the breadth of Section 1031, it might seem like all types of properties can qualify for like-kind exchanges. But this isn’t the case. There are several exceptions, and your 1031 exchange facilitator will be able to help ensure that you do not unknowingly attempt to execute an exchange with a non-qualifying property.

So, what types of properties don’t qualify for like-kind exchanges? Some examples include:

• Primary Residences (Though There Are Exceptions) – Primary residences generally do not qualify for like-kind exchanges if you are simply selling your home to purchase another one. However, there are steps that investors can take to secure like-kind exchange treatment for transactions involving primary residences.
• Property Held Primarily for Sale – If a property is held “primarily for sale,” it is not eligible for like-kind exchange treatment under Section 1031.
• Ownership Interests in Business Entities – As a general rule, ownership interests in business entities are not eligible for like-kind exchanges, even if a business entity’s primary purpose is to own a piece of real estate.
• Personal Property – As noted above, while personal property used to be eligible for like-kind exchange treatment under Section 1031, this changed when the Tax Cuts and Jobs Act took effect in 2018.

Again, these are just examples. Each individual circumstance is unique, and, as a result, it will be important to discuss your proposed exchange with an experienced 1031 exchange facilitator. Once you are confident that you are prepared to move forward, your 1031 exchange facilitator can then guide you through the next steps in the process.

Speak with a 1031 Exchange Facilitator for Free

If you are interested in learning more about the like-kind exchange process, we invite you to get in touch. Please call 888-872-1031 or request a free consultation online to speak with a 1031 exchange facilitator at 1031 National Services.