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Like-Kind Property Exchange Explained
What is a “Like-Kind” exchange and what do I need to know when buying and selling commercial real estate?September, 2021 As a commercial real estate agent in Salt Lake City, Utah, I get asked this question multiple times every week as I work with commercial property owners looking to buy and sell. I’ve written this article to explain “Like-Kind property” assets and how to meet the IRS Code definition when buying and selling real estate in Utah.
The term like-kind property refers to two real estate assets of a similar nature regardless of grade or quality that can be exchanged without incurring any tax liability. The Internal Revenue Code (IRC) states this about like-kind property, “Like-kind exchanges — when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” — have long been permitted under the Internal Revenue Code. Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received. You can’t recognize a loss.” In short, the main purpose of this tax deferral is to keep real estate investors investing in future properties, instead of pulling their money out of the market without reinvesting. Learn more about 1031 Exchanges in Utah on my blog.
What is a “Like-Kind” Property?In a like-kind exchange, property owners can defer paying capital gains on the sale of their properties. This is possible because they have to swap with another party’s qualifying business or investment property and it must meet certain requirements set out by the IRS in order for this tax treatment to be given. In short, there cannot be a direct sell off of these assets through one single transaction—rather, an indirect method that involves a qualified 1031 intermediary, who will hold the funds in escrow before you use them to purchase your next property. The money can not commingle with your personal funds at any point, or the exchange becomes invalid, and taxes become due. The timeline for a 1031 exchange is also very strict. For example, when an individual sells a commercial space, they must identify a replacement property within 45 days. After the identification period has passed, they must close on one or more of those identified properties within 180 days. It’s important to note that like-kind exchanges are not limited by the size of the property, rather they’re judged on how much income it might generate or what could be built there in the future if something were demolished and replaced with something new. An apartment complex valued at $200K can be exchanged for a shopping center valued at $200K, if the like-kind replacement property is of equal or greater value. Some examples of like-kind properties that can be exchanged include:
- A multifamily property for a Hotel.
- Raw Land for a medical complex.
- An apartment building for an office building.
- An Industrial Building for a retail property.
- A single family home rental for a flex space industrial rental.
*This article is informational only and should not be construed as tax advice. Please consult your tax professional to offer specific advice or instructions on filing your taxes.