What is a 1031 Like-Kind Exchange?

A 1031 like-kind exchange is a tax-deferred exchange that gets its name from the United States Internal Revenue Code, Section 1031. This is an exchange in which a person subject to United States taxes can sell property or other assets and replace it with a like-kind asset. With this type of exchange, capital gains taxes can be deferred. However, there are rules that must be followed concerning the deferment.

Usually, when a person sells an asset or investment, he is taxed on the sale at the time of sale. With a 1031 like-kind exchange, however, things are handled a bit differently. If the money from a sale is reinvested into a similar property or asset, the person may be able to avoid paying taxes on the sale of the asset or property for years. Additionally, the exchange only has to include assets that are similar; they don’t have to be exactly alike. For example, a person may have a like-kind exchange situation if he sells an office building and reinvests in an apartment building.

With a 1031 like-kind exchange, the investor is not free from taxes on the initial sale indefinitely. The sale can be taxed later, such as when the new property is sold. As such, some people may look at the 1031 like-kind exchange as a loan from the government that does not result in interest charges.

Some of the rules governing like-kind exchanges involve the type of property that is involved. To count as a like-kind exchange, the exchanged property must be intended for purposes of investment, trade, or business. A vacation home or personal residence will not qualify for this type of exchange, but an office building or vacant lot could. Also, stocks and bonds that are held for sale do not qualify for like-kind exchanges. Depending on the particulars of the situation, both real and personal property may be eligible for a like-kind exchange.

There are five types of 1031 like-kind exchanges. One is a simultaneous exchange, which means the investor sells or otherwise disposes of the initial property at the same time as he gains the new property. A delayed exchange occurs when there is a period of delay between selling one asset and buying another. However, the Internal Revenue Code lists strict requirements for how much time may pass between the buying and selling. If an investor fails to meet the deadlines, he may be taxed on the entire exchange.

A complicated type of exchange is called the reverse exchange, and it involves gaining a new asset before selling the original property. An investor only has 180 days to sell the original property and take advantage of this type of exchange. In a built-to-suit exchange, a person may use the earnings from selling the initial property to finance improvements to the newly acquired property. A personal property exchange occurs when personal property is exchanged for similar personal property.