What is a Like Kind Exchange in Real Estate? A like kind exchange is the transfer of real estate which involves the sale of real property and a subsequent purchase of replacement property by a taxpayer without triggering capital gains taxes from the initial sale. Many different types of transactions may qualify for a like-kind exchange but our focus is on the sale and acquisition of one real estate investment property or property used in the conduct of a trade or business for another. For taxpayers who are eligible, like-kind exchanges are a beneficial way to sell and invest in real estate without significant tax consequences.
How Does it Work? Section 1031 of the Internal Revenue Code provides allows a taxpayer to defer capital gains taxes relating to an exchange of like-kind property if certain requirements are met. It is important to note that the taxes are deferred and not completely avoided. In general, the taxpayer must comply with the following:
- New property and old property must be “like-kind.”
- Property must be held for investment or business purposes (personal residence excluded).
- Value of new property must be equal to or greater than the value of old property.
- New property must be identified within 45 days and acquired within 180 days of the sale of the old property.
- The transaction must be properly structured property. For example, use of a qualified intermediary to receive proceeds from the sale of the old property.
What is Like-Kind?
The Code provides minimal guidance on the definition of what constitutes like-kind. Treasury Regulation § 1.1031(a)-1(b) simply provides that like-kind refers to “the nature or character of the property and not to its grade or quality” without further distinguishing what constitutes the nature, character, grade or quality of a property. In practice, however, the definition of like-kind relating to real estate property has been fairly broad.
What are some things to look out for?
In order to defer capital gains from the disposition of the old property completely, the taxpayer must ensure that the value of the old property does not exceed the value of the new property. If the value of the old property is greater, the taxpayer will be taxed on capital gains for the positive difference between the value of two properties in the tax year that the property was sold.
Personal property is subject to more rigorous rules than real estate property. If the exchange of the real property includes personalty, the taxpayer must take caution to ensure that the personal property also complies with like-kind restrictions which are more stringent than the real estate definition.