DEFINING THE SECTION 1031 EXCHANGE TERM "lIKE-KIND"
Many people hear the term "like-kind" when they're talking about
Section 1031 exchanges and they start to panic. Please, relax! I've got
an easy way for you to figure out whether two properties are like-kind to each other for purposes of exchanging.
First of all, a caveat... the easy way only applies to real estate
exchanges. I'll talk more about other types of exchanges later, but
suffice it to say that it is more difficult to determine like-kind
status in those exchanges. With real estate, however, it's pretty
simple. I've heard other exchange people say, "All real estate is
like-kind to all real estate." In my opinion, that simplifies things a
little too much, and I'll give you an example why later.
For the meantime, here is the secret to determining whether a piece
of real estate is like-kind to another piece of real estate within the
exchange context: Ask yourself (or your client, if you are a real
estate, tax, or legal professional) these questions:
- (Regarding the property being sold) Did own this property with the
intention of holding it as an investment or using it in the pursuit of
my business or trade?
- (Regarding the property being purchased) Do I intend to hold this
property as an investment or use it in the pursuit of my business or
If you (or your client) can answer, "Yes" to both of those questions
and can substantiate his or her answer, the two properties are
like-kind for purposes of exchanging.
Is a farm like-kind to an apartment building? In the vast majority
of cases, the answer is yes. Is a rental house like-kind to a
small-town office building? In the vast majority of cases, the answer
is yes. Is a single-family home that was purchased with the intention
of fixing up and reselling like-kind to a duplex? AHA! Here's an
example of why all real estate is NOT like-kind to all real estate.
Clearly the single-family home being rehabbed is real estate, but the
IRS considers this property to be inventory in a business and not
something that was purchased with the intention of being held for
investment. I can hear you arguing "This was an investment!! I invested
my hard-earned dollars to buy the house and now I'm investing my
hard-earned dollars to fix up the place. Why doesn't that make it an
investment??!?" A solid argument, I will admit, but one which you will
lose when you face the IRS examiner.
It all comes down to the intent. Did you
buy the property you are now selling with the intention of holding it
as an investment? No, your intention was to fix it up and sell it. So
it does not qualify for a Section 1031 exchange.
I promised to talk about non-real-estate exchanges, but this has
already gotten a little lengthy. Let me bring this to a close by saying
that the exchanges of business assets, etc. require a much higher
standard when determining like-kind status. The IRS uses Asset Classes
and Product Classes to determine whether two items are like-kind. The
items must fall within the same class to qualify. I will write an
article on business asset exchanges in the future and address this issue
more thoroughly. For now, just remember the two questions and you will