Like-kind exchanges are often a misunderstood topic in the 1031 exchange world. As the market continues to improve it seems that many investors have the desire to exchange into a different form of real estate investment. This leads us to the question: What are like-kind properties?
Commonly Asked Questions
If you’re interested in like-kind exchanges then you likely have a lot of questions about how they work. Here’s some of the most commonly asked questions regarding like-kind property exchanges, and make sure to check out the full video for more details!
What is a like-kind investment property?
Like-kind refers to the nature of the investment. Any type of investment property can be exchanged for another type, or like-kind investment property. For example, a single-family rental can be exchanged for a duplex, raw land for a shopping center, an office for apartments. Any combination works and provides exchangors with great flexibility.
What type of investment property qualifies?
Any property held for productive use in trade or business or for investment can be exchanged for like-kind property. When exchanging real property the definition is very broad, though exchanges of “personal” property can be very tight.
Like-kind exchanges with a 1031 exchange can be a great tool for expanding your real estate investment portfolio. Watch the video or read the full transcript below to learn how the like-kind exchange works.Read the Full Transcript
David Moore: Hello, David Moore with Equity Advantage 1031exchange.com. And today’s question is, what’s the definition of like-kind with respect to 1031? And that’s something that’s often discussed and people have a lot of misinformation out there on it. And if we’re looking at the rules we used to have to apply it to personal property to, in 2017, we lost personal property transaction. So now we’re just looking at real property.
So if we look at the like-kind requirement, when applied to real property, it’s very, very broad. It just refers to the nature of the investment rather than the form. So any real property relinquished that was held for investment is going to be like tying with any replacement property acquired with the intent to hold for investment. What does that mean? What does held for investment mean? How long do you have to hold something?
David Moore: And those are great questions. And unfortunately I don’t have black and white answers, or maybe that’s good that I don’t have black and white answers. If you’re pushing and asking me how long you should hold something to have to qualify, I’m going to tell you a year based upon a couple of different factors, but when we’re looking at like-kind situation, things that are going to fall outside, if we’re looking at real property, that’s not going to qualify for your 1031, we’re going to be looking at a situation where you couldn’t buy a new home to live in. That’s not going to be acquired with the intent to hold for investment. And we’re in a situation where maybe you’ve seen an ad or read, or maybe you do flipping properties.
Well, a flip property is not something held for investment, and it doesn’t really matter how long you take to improve that property, if you bought it with the intent to improve and turn it, you’ve held it for resale. And therefore it’s not going to qualify for 1031, regardless of how long you hold it. And secondly, you’re going to have a situation where you’re not going to get longterm capital gains tax treatment on that gain either.
David Moore: So really look at that stuff, understand most of the time people come to us looking at flipping properties, they’re going to do a few of them. They’re going to lose so much in taxes, they get over it quickly and they’re going to do what we would call a modified flip, something that’s been around for… I’ve been in the real estate business for over 30 years and has been around a lot longer than that. I get a kick out all these new formulas that people come out with the acronyms explaining these new ideas that have been around for decades.
But a modified flip would be a situation where you buy it, you fix it, you then rent the thing out, hold it for investment for a period of time. If you want the money out of it, you can do a cash out refi and what you get via the refi is probably going to be an excess of what you would have had net of taxes.
David Moore: So that’s a great solution. Maybe a year or two later, you then do an exchange. So we’re looking at that held for investment requirement, and then it’s not a time issue. It really has to do with intent more than anything. So once again, any real property relinquished has been held for investment’s going to be of like-kind with any real property acquired with intent to hold for investment. You can go from that dirt into an office building, a strip mall, single family rental is going to be like-kind with the mini storage.
It doesn’t matter as long as you’re relinquishing and receiving property that was held as an investment and acquired with the intent to hold for investment. The next question is going to be, as I said, how long does something have to be held? And it really has to do with a variety of factors.
David Moore: We look at a court case, the Clarkowski court case. It’s very, very old. It contains nine points that we use to determine dealer status. I use that same case when I’m looking at with respect to IRAs and 401K plans and unrelated business, taxable income. So we’ve got situation with IRAs, for example, where if you’re conducting a business with that account, even if you had a Roth IRA, you’re going to have tax exposure. If it’s a leveraged investment on the income or gain attributed to the leverage, or if it’s something that you’re conducting business retirement account, even with a Roth, you’re going to have tax exposure.
So once again, back to 1031 application, what is like-kind? It just refers the nature of the investment rather than the form. And that’s the tool. That’s one of the secrets that allows people to start off with that basic rental house and grow and amass a nice portfolio of investment real property over time, because you can take from that rental house, into the plex, into the multifamily, into the big box, into whatever it might be.
David Moore: And the typical scenario is at the end of the day, somebody is going to exchange out of these properties that require management. And at some point you get tired of the terrible Ts, especially with all the rent control issues today, toilet, trash, tenants, turnover, and now it’s trouble I would say, on top of that. So we end up at a point at some point where people are saying, “Hey, I’m done with that stuff.”
And DST, Delaware Statutory Trust is one of those places people go. It satisfies the exchange requirements, and it’s going to be your way out without having to pay the tax, maintaining tax deferral and giving you the benefits of ownership of real property. So if you’ve got questions on this topic, give us a call. Actually, one more comment on what’s like-kind. Improvement exchanges, think about what we do with an improvement exchange.
David Moore: For those of you that are not familiar, you’re giving up property that you’ve held for investment. You’re going to buy a property. You want to build that thing out. It could be minor improvements, it could be ground up construction. But what happens is we’re going to acquire… We, as in the exchange company is going to actually acquire, take ownership of the property, do the improvements to convey the improved property back the taxpayer, completing the exchange.
So let’s say we get close to the 180th day and we still got $50,000 left. Could you go out and prepay labor and materials and have, let’s say a stack of lumber sitting onsite and have that represent tax deferral? The answer’s no. Okay. What’s completed is going to satisfy and be of like-kind, so whatever’s real property and at that point, a transfer is going to qualify, but you can’t prepay labor and material. That’s not of like-kind, that same thing is pulling cash out of the transaction. But I hope this has helped. And this is a topic that comes up all the time and people a lot of times and say, “Hey, I remember it was a house for house, land for land.” And it’s never been that way.
David Moore: So once again, with 1031, there’s so much misinformation out there. That’s why I say there’s no such thing as a dumb question, ask the question, give us call and we’ll do what we can take care of you. Thank you for joining us today. David Moore, Equity Advantage 1031exchange.com. Take care.
Got questions about like-kind exchange and what qualifies for an IRC section 1031 exchange? Give Equity Advantage a call today at 503-635-1031