A like-kind property refers to two assets that are considered to be the same type, making an exchange between them tax deferrable. The two assets must be of the same kind but do not need to be of the same quality to qualify as like-kind property.
For example, a single-family rental could be sold and the proceeds invested in a multi-family property without triggering capital gains. In the United States, a like-kind property transfer with a tax deferral is called a Section 1031 exchange, referring to the portion of the tax code dealing with like-kind property transfers.
IRS Determination of Like-Kind Property
The like-kind property must meet the definition set out by the Internal Revenue Service (IRS) to qualify for a Section 1031 transfer. The properties in question must be used for business or as an investment. This limitation is meant to exclude primary residences which are, by default, for personal use the majority of the time. The like-kind property also must be within the United States to qualify.
For example, a seller cannot use the proceeds from selling a hotel in the U.S. to buy a hotel in Dubai and expect to defer capital gains on the sale. Securities, stocks, partnership interests, and other financial assets are excluded from the definition of like-kind property.
How a Like-Kind Property Exchange Works
A like-kind property exchange must follow the timelines set out by the IRS. If an investor sells farmland, for example, he has 45 days to identify a replacement property. The purchase of the like-kind property must be completed within 180 days of the farmland sale or by the due date for the tax return that year. The IRS may grant an extension on the taxes to allow for the like-kind exchange to be completed before filing.
Like-Kind Property in a Changing Tax Code
The like-kind property exchange for real estate transactions is still in force, but various changes to the tax code have chewed away at other parts of the definition. In the past, the like-kind property exchange has been used for assets that include everything from cars to art to cryptocurrency holdings.
The Tax Cuts and Jobs Act passed in December 2017 removed everything but real estate held for business, trade, or investment. There has been a robust debate on why real estate should enjoy such favored tax status when other investments like machinery and equipment must deal with capital gains on every sale regardless of reinvestment. As of 2018, however, the like-kind property exchange is still an excellent way to build tax-deferred wealth in real estate.