Legal Definitions - like-kind property

Like-kind property refers to real estate that is considered similar enough in nature or character to another piece of real estate, allowing an investor to postpone paying capital gains taxes when one investment property is exchanged for another. This tax deferral mechanism is known as a 1031 exchange, named after the relevant section of the Internal Revenue Code.

For an exchange to qualify, both properties involved must be held for investment or for productive use in a trade or business, and not primarily for personal use or quick resale. While the properties don't have to be identical, they must be of the same general type of real estate. For example, raw land can be exchanged for a commercial building, or an apartment complex for an industrial warehouse. The investor must identify the replacement property within 45 days of selling the original property and complete the purchase within 180 days. Additionally, the value of the replacement property must generally be equal to or greater than the property sold to fully defer taxes.

Here are some examples:

• Example 1: Commercial Properties

  A real estate investor owns a small retail storefront in a bustling city district. They decide to sell it to take advantage of a strong market. Instead of immediately paying capital gains tax on the profit, they use the proceeds to purchase an office building in a different part of the state, which they intend to lease out to businesses.

  Explanation: Both the retail storefront and the office building are considered "like-kind property" because they are both investment real estate. Even though one is a retail space and the other is an office space, they are both held for investment purposes and generate income, thus qualifying for a 1031 exchange to defer capital gains taxes.

• Example 2: Agricultural and Ranch Land

  A landowner owns a large tract of undeveloped agricultural land that they lease to local farmers for crop cultivation. They decide to sell this land and use the funds to buy a ranch property that includes both grazing land and a small farmhouse, which they also plan to lease out for agricultural purposes.

  Explanation: In this scenario, the agricultural land and the ranch property (including its structures used for agricultural purposes) are both considered "like-kind." They are both real estate held for productive use in a business (farming/leasing) and are of a similar nature, allowing the landowner to defer capital gains on the sale of the original land.

• Example 3: Residential Rental Properties

  An individual owns a duplex that they have been renting out as an investment property for several years. They sell this rental duplex and, within the required timeframe, purchase a small apartment building in another city, intending to continue generating rental income from multiple units.

  Explanation: The duplex and the apartment building are both "like-kind property." They are both real estate held for investment purposes, specifically for generating rental income from residential tenants. This exchange allows the investor to defer capital gains tax on the sale of the duplex.