The term “like-kind” is one of the most misunderstood concepts in 1031 exchanging. Many investors assume it means you must exchange one type of property for an identical type, but the IRS definition is actually much broader than most people realize.
What “Like-Kind” Actually Means
Like-kind refers to the nature or character of the property, not its grade or quality. In practice, this means that virtually any type of investment real estate can be exchanged for any other type of investment real estate. The properties must be held for investment or productive use in a trade or business.
Examples of Like-Kind Exchanges
You can exchange an apartment building for a retail shopping center. You can exchange raw land for an office building. You can exchange a single-family rental for a commercial warehouse. The flexibility is remarkably broad.
What Does NOT Qualify
Personal residences do not qualify for 1031 treatment. Property held primarily for sale (such as a developer’s inventory) does not qualify. Foreign real property cannot be exchanged for domestic real property. Partnership interests are also excluded.
Mixed-Use Properties
Properties that are partially used for personal purposes and partially for investment may qualify for a partial 1031 exchange on the investment portion. Careful documentation and allocation is required.
The Key Takeaway
The like-kind requirement is far more flexible than most investors realize. If you own investment real estate of any type, chances are excellent that you can exchange it for virtually any other type of investment real estate and defer your capital gains taxes.