Like-kind property refers to pieces of property that are considered to be of the same type as far as the tax code is concerned. This means that an exchange of one for the other is tax deferrable. An important distinction is that the properties only need to be of the same type to qualify for tax deferment – not the same quality. This means that a single-family rental could be sold, and the money earned from its sale could be invested in a multi-family rental, and taxes on the transactions would still be deferred.
More specifically, the Internal Revenue Service (IRS) has set a definition for like-kind property that must be satisfied for such an exchange to temporarily avoid being taxed. First, the properties in question must be used in business or as an investment. Therefore, private residences are disqualified, since they are for personal use. Next, both properties must be physically located within the United States. If either of the properties in the exchange is outside of the United States, then your taxes won’t be deferred. Finally, property in this context means real estate, so intangible property like stocks won’t qualify.
To successfully perform a like-kind exchange, you must follow the procedure established by the IRS. As an example, if you sell your land, then you have 40 days to identify a like-kind replacement for it. The purchase of the like-kind property must then be completed within 180 days of the sale of your original property or by the filing due date for that year’s tax return. The IRS may, in its discretion, grant an extension in which to file your taxes that year in order to allow you to complete the like-kind exchange before you file.
Before attempting to carry out a like-kind exchange, you should know that this practice is in a state of flux. As of right now, this type of exchange can still be carried out; however, the tax code has undergone recent changes that have gradually chipped away at the definition of like-kind property. For example, some intangible and personal property, like art, could previously be the subject of a like-kind exchange, but now only real estate is permitted. The wisdom of this change has been harshly criticized as arbitrarily favoring real estate investment over other forms of intangible investment. Given the shifting landscape of this section of the tax code, it is highly recommended that you meet with a lawyer before attempting to perform a like-kind exchange to ensure that the assets you are exchange qualify. Adam Leitman Bailey, P.C. has the experience and knowledge to help.
At any rate, the like-kind investment remains a powerful tool for real estate investors to temporarily avoid capital gains taxes on the transfer of real estate, so long as that real estate is of like-kind.