Guide to Like-Kind Exchanges

By Edward E. Fernandez | August 14, 2021

Guide to Like-Kind Exchanges

If you are an investor and considering selling your investment property and purchasing another, you may want to do a like-kind exchange. With a 1031 like-kind exchange, you can sell your investment property, purchase a like-kind property and defer capital gains tax.

At 1031 Crowdfunding, we want to help you through the process of a like-kind exchange. This like-kind exchange guide includes the basics of the rules, definitions and concepts you may want to understand before you jump into the 1031 like-kind exchange process.

What Is a Like-Kind Property or Like-Kind Exchange?

Like-kind property refers to a property with the same character or nature or that is part of the same class. The property’s grade or quality does not matter. Most real estate properties will be like-kind to other properties.

The requirements for a property to be like-kind are relatively liberal. For example, you can exchange a rental home for a retail building, an apartment complex for an industrial building or raw land for a senior care center.

One exception is that improvements conveyed without land will not be like-kind to land. Another exception is that real estate in the U.S. is not like-kind to properties outside the country. Other assets that do not qualify as like-kind include:

  • Debt
  • Bonds
  • Stocks
  • Inventory
  • Securities
  • Trust certificates
  • Partnership interests

If a property is not like-kind, the IRS may tax you for the total sale amount, though you may not know about this until you file the forms to claim your tax advantage for the 1031 exchange. It’s critical to understand the rules and restrictions of 1031 exchanges before you proceed.

1031 Like-Kind Exchange Rules

A real estate investor who sells a property may be able to take advantage of the IRS tax code that allows you to defer depreciation recapture and capital gains on the property, which is a 1031 like-kind exchange.

What Is a 1031 Like-Kind Exchange?

 

A 1031 like-kind exchange occurs when you exchange a real property that you held as an investment or used for business with another investment or business property that is like-kind. Under Section 1031 of the IRS code, the law typically does not require you to recognize a loss or gain.

What Are Like-Kind Exchange Rules?

You must adhere to specific rules for a successful 1031 like-kind exchange. If you receive other property or money that is not like-kind in the exchange, the exchange does not qualify and you will have to pay taxes.

Section 1031 has adjusted due to the Tax Cuts and Jobs Act and applies only to an exchange of real property. Section 1031 does not apply to exchanges of intangible or personal property. The following belongings typically do not qualify for the non-recognition of a loss or gain as like-kind exchanges:

  • Artwork
  • Patents
  • Vehicles
  • Machinery
  • Equipment
  • Collectibles
  • Intangible business assets

How 1031 Like-Kind Exchanges Work

If you want to do a 1031 exchange, you should know the steps involved in the process. Many investors need to perform a delayed exchange, also known as a Starker exchange or a three-party exchange. Generally, 1031 like-kind exchanges follow the steps below.

1. Getting a Qualified Intermediary Involved

After you decide to do a 1031 like-kind exchange, you will need a qualified intermediary. This company or person does not have any stakes in the 1031 exchange, and they manage the funds involved. Your qualified intermediary sends the money to the seller.

A third party gets involved, holding funds on your behalf until the purchase. Your qualified intermediary should not have any other formal relationship with you or the other party involved in the exchange.

2. Finding a Property

To complete the like-kind exchange, you have 45 calendar days to find a property. After this window of time closes, the exchange will be disqualified and taxable. Because this is a short timeframe, we encourage you to research an exchange before selling your property. The good news is there are several identification strategies available, including the three-property rule, the 95% exception and the 200% rule.

  • Three-property rule: This rule, also called the three-property identification rule, lets investors find a maximum of three like-kind properties that could be potential replacement properties, regardless of the fair market values. This method is popular because it allows investors to have backups.
  • 95% exception: With the 95% exception, you can find unlimited replacement properties and any fair market value, as long as you acquire and close on 95% of the market value.
  • 200% rule: According to the 200% rule, you can find unlimited like-kind replacement properties, as long as the total value of the properties doesn’t exceed 200% of the total net sales value from the relinquished property.

3. Buying a Replacement Property

You have a window of 180 calendar days to complete your exchange after the day of your property sale. As such, you need to buy a replacement property and have your qualified intermediary transfer funds by the deadline. This deadline may be shorter depending on the income tax return’s due date.

If you do not complete the sale before the deadline, your funds from the sale will be taxable.

 

If you are looking for an online marketplace on which you can complete 1031 exchange investments, 1031 Crowdfunding is the solution for you. We have more than eight decades of combined years in real estate. Browse our marketplace of 1031-eligible properties.

Our representatives will guide you through every step of the process to make sure you complete your 1031 exchange efficiently and correctly. After you join, you will fill out your paperwork online. The properties we offer have already been closed on in most cases, which removes any closing risk for you, and our clients can close in as little as three to five days. Join the crowd at 1031 Crowdfunding by registering for an investor account today.

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