What Are Like-Kind Properties?

What Are Like-Kind Properties?

For real estate transactions under Section 1031 of the Internal Revenue Code, where capital gains taxes can be deferred, the term “like-kind” is used to define the properties that can be exchanged. Like-kind is essentially saying that the two properties being exchanged are of the same nature or kind, but do not have to be exactly the same grade or quality. 

To qualify as like-kind, the properties must be held for the same purpose, such as business, investment, or as a productive use in a trade. The money made from the relinquished property is then held by a third party until a replacement property is found and closed on. For example, you may purchase a property such as a business or lot of land as an investment, and the replacement property must be like-kind to the previous property. This is known as a 1031 exchange and is used to defer capital gains taxes on income made from the real estate property. 

The following can qualify as like-kind properties:

  • Rental homes, condos, and apartments.
  • Farmland and raw land.
  • Commercial office buildings.
  • Retail properties.
  • Industrial properties.

Both, or more, properties can differ in market value, square footage, improved or unimproved, and still be like-kind. 

What You Should Know About Like-Kind Properties

You should consider the following before a 1031 exchange:

  • The replacement property does not have to be in the same state as the original property, but it does have to be in the United States; Puerto Rico and 11 other U.S. territories are not included. 
  • The replacement property does not have to be the same asset class to be like-kind. For instance, a commercial property is like-kind to an undeveloped property. 
  • Property rights do not have to be the same for both properties to be like-kind, but there are some restrictions. For example, the relinquished property may have permanent rights with improvements and is like-kind to another property with permanent rights, but not the replacement property’s improvements. 
  • For the 1031 exchange, properties must be like-kind, such as rental homes, office spaces, and farmland. These are like-kind because of their lease or rental agreements that generate income, and they are not owned for personal use. According to the Internal Revenue Service (IRS), the property must be held for productive use.
  • If a property owner resides in a rental property, then only the rental portion of the property is considered like-kind, not the owner’s residence portion. 
  • Primary residences or vacation homes do not qualify as like-kind and are not investments, thus cannot be used for the 1031 exchange. 

The IRS determines what is like-kind. If the IRS finds that you are holding a property for sale or resale, then it is simply known as a “flip” and would not qualify for the 1031 exchange. The IRS defines what qualifies for a 1031 exchange by considering the owner’s intent at the time of sale as well as how the property is used during ownership. 

To determine intent, the IRS considers how frequently the property has been sold or resold in the past, as well as if there were improvement projects. The IRS also considers the owner or taxpayer of the property and how many properties they previously owned.

1031 Federal Exchange Can Help Investors Understand Like-Kind Properties

A 1031 exchange can be a complicated process, even for experienced investors. The best way to navigate such a complex transaction is to look to our qualified intermediary at 1031 Federal Exchange. Call us at 513-450-3039 or fill out our online form for a free consultation. Located in Loveland, Ohio, we proudly serve clients nationwide.