Like-Kind Property Explained

In a 1031 exchange, the owner of a property can “exchange” their property for another and defer capital gains tax. Essentially, the property owner sells their current property (known as the relinquished property) and uses that capital to fund the purchase of a new property (known as the replacement property). However, both the relinquished and replacement properties must be “like-kind.” 

Let’s take a closer look at what makes a property “like-kind” with another and go over some examples to help solidify this important distinction. 

Understanding Like-Kind Properties 

The good news is that, for the purpose of real estate transactions, like-kind property is easy to define. All types of real estate within the United States is areconsidered like in kind to all others. So, an undeveloped plot in a city is considered like-kind to a ranch or farmland; similarly, an apartment building is considered like-kind to a shopping center for 1031 purposes.  

However, 1031 exchanges have other requirements in addition to the two properties being like in kind. They must also be used for investment, trade, or business purposes. So, while personal homes would not qualify as like-kind for a 1031 exchange, the following types of property would: 

• Multifamily properties 
• Condominiums 
• Farmland 
• Long-term rental properties 
• Short-term rental properties (i.e. homes used for Airbnb or VRBO) 

Other Examples of Like-Kind Properties 

All real estate located within the United States is considered like in kind to all other real estate, but there are some special cases that also qualify. For example, while real estate in U.S. territories like Puerto Rico do not qualify as like-kind, real estate in the U.S. Virgin Islands, Guam, and the Northern Mariana Islands qualifies, so long as all other 1031 requirements are met. 

Below, we’ve listed different types of interests in real estate that may qualify as like-kind to a typical, fee simple interest (the most frequently exchanged real property interest) for purposes of a 1031 exchange. 

Trusts 

Generally, certificates of trust or beneficial interests in trusts are not considered like-kind for the purpose of a 1031 exchange. However, beneficial interests in land trusts in a growing number of states, including the below, qualify: 

• Florida 
• California 
• Hawaii 
• Indiana 
• North Dakota 
• Virginia 
• Illinois 

Additionally, a beneficial interest in a Delaware Statutory Trust (DST) can be qualifying property in an exchange, since the beneficiary is treated as owning an undivided fractional interest in the DST’s real property for federal tax purposes. 

Leaseholds 

Leaseholds may be considered like-kind to a fee interest in real estate for purposes of a 1031 exchange in specific circumstances. A leasehold interest with an unexpired term of greater than 30 years (including optional renewal periods) is like-kind to a fee interest. This "30-year rule" also applies to other terminable interests (e.g., a life estate or estate for years). 

A lessor cannot exchange a lease for a fee interest in real estate – their interest is considered a right to receive income and is thus personal property (not real estate). However, a lessee can exchange a leasehold interest for a fee interest. 

Development Rights 

Development rights are a relatively modern land use planning tool that local governments grant to limit or prevent development in special zoning districts. These rights can be sold on the open market to owners of other real property in a receiving zone, permitting development of property in that zone beyond what would otherwise have been permitted. The tax statutes and transfer tax provisions in most states usually define development rights as real estate. 

The IRS has held that a fee interest in real property is like-kind to development rights with respect to other property that the taxpayer already owns, provided the development rights are considered real property under state law. 

Water Rights 

Perpetual water rights are considered like-kind to a fee simple interest, provided that the rights are not limited in amount or duration. Additionally, shares in a mutual ditch, reservoir, or irrigation company can be exchanged if certain requirements are met: 

1. The company is an organization described in I.R.C. § 501(c)(12)(A). 
2. The shares in the company have been recognized as constituting an interest in real property. 

Mineral Rights 

Certain mineral rights may be considered like-kind to a fee simple interest for the purpose of a 1031 exchange. However, this largely depends on the laws within the property owner’s state. If the state considers the mineral rights to be real property for tax purposes, then those rights likely will be considered like-kind by the IRS. 

Examples of Non-Like-Kind Properties 

Like-kind property does not include foreign real estate (i.e. real property located outside the United States). Other types of property that do not qualify as like-kind include: 

• Stock-in-trade (property held primarily for sale) 
• Stocks, bonds or notes 
• Securities or evidence of indebtedness or interest 
• Interests in a partnership 
• Certificates of trust or beneficial interest 
• Chooses in action 
• Primary residences 
• Personal property 
• Cash 

Like-Kind Properties: FAQs 

Still have questions on the like-kind property requirement or 1031 exchanges in general? Check out some of the most frequently asked questions below. 

What qualifies as a 1031 property? 

To qualify for a 1031 exchange, the relinquished property and the replacement property must be like-kind in nature. They also must be held for the purposes of investment or productive use in a trade or business. Selling your primary residence, then, would not qualify for a 1031 exchange to defer capital gains tax. 

What is the 200% rule for like-kind exchange? 

The 200% rule means that, while an investor can identify as many replacement properties in a 1031 exchange as they want, the total fair market value of those properties cannot exceed 200% of the fair market value of the relinquished property. In this way, an investor can diversify their investment by using the funds they receive from the sale of one property for several others. 

Can I use a 1031 exchange for my primary residence? 

No, primary residences are not eligible for a 1031 exchange. The relinquished property must be held solely for investment or business purposes, such as rental properties, multifamily buildings, or commercial real estate. 

What is the two-year rule for a 1031 exchange? 

IRS regulations say that all property in a 1031 exchange must be used for investment or business purposes. However, this means property that has been held for a short time might not qualify, as it can be difficult to make the case that the property was intended for investment. The IRS has issued a non-binding private letter ruling in which property owned for at least two years was considered investment property, which has led to a common misconception that there is a 2-year rule. In fact, the rule is simply that an investor must show there was an intent to hold the property for investment – a longer holding period makes this easier to prove. 

Get Help on Your 1031 Exchange Today 

If you’re an investor looking to perform a 1031 exchange, it’s crucial to ensure that all the proper steps are taken and that all property involved in the proposed exchange qualifies under IRS rules. The like-kind requirement is just one condition that you must meet in order to defer capital gains taxes on the sale of your relinquished property. 

Let the trusted Qualified Intermediaries at First American Exchange Company help you with your 1031 exchange. Open an order with us today to start the process.