When a real estate investor sells a property, they might be eligible for a deferment of capital gains taxes through a 1031 Exchange if they purchase a replacement property called a like-kind property.
So, what exactly does the IRS consider a like-kind property?
The term is misleading to some people who assume it means that the replacement property must be similar in type and quality to the sold investment. However, a like-kind property can be almost any type of real estate.
One of the most important factors in defining a like-kind property is that it must be an investment or for business use. It cannot be for personal living of any sort, including a vacation home or a second home.
Besides being an investment and not a personal residence, a like-kind property:
Example: An investor can exchange a property sold in Texas for an investment in Michigan.
Example: An apartment building can be exchanged for farmland, or an office building can be exchanged for a retail property.
Example: Even if the investor relinquished one property, the exchange could be for multiple properties, and vice versa. Again, the caveat is that the value must be equal to or greater value.
Example: An investor can hold part ownership in a property if they do not want to self-manage the property.
Example: An inherited property is sold into a DST, maintaining equity but separating themselves from the property.
Additional examples of like-kind property exchanges include unimproved property for improved property, vacant land for a resort property, or a duplex home for an office building, among others.
While the definition of a like-kind property seems to be broad, there are some things to keep in mind.