A like-kind exchange allows you to exchange one investment for another investment, under certain circumstances. There are like-kind provisions for life insurance policies, cars, equipment, and real estate. The real estate like-kind exchange, also known as a 1031 exchange or a starker exchange, is probably the most common.
The like-kind exchange is described in Section 1031 of the Internal Revenue Code and is further defined in a court ruling, Starker v. Commissioner—hence the other names. This is a specific exchange of real estate that has been held for business or investment. You cannot do a Section 1031 like-kind exchange on your personal residence or on non-real estate items. A like-kind exchange allows you to sell a piece of property that is highly appreciated and roll over the gain into another piece of property. You don’t pay tax on the sale now.
The second piece of property merely has to be another piece of in-vestment real estate property. It does not need to be exactly the same kind of property. For example, you could exchange a single-family residential rental for a piece of commercial land. Or you could exchange an apartment building for a shopping center.
There are some rules for the like-kind exchange that must be closely followed. We strongly recommend that you have an exchange accommodator help you with the details of the exchange. An ex-change accommodator is someone who comes from a specialized profession that only handles property exchanges. Neither your accountant nor your lawyer can fill this position for you. In general, you must declare three possible choices for the exchange within 45 days and you must close on the replacement property within 180 days. You need to invest all of the cash from the sale into the next property, and the next property must be purchased for at least as much as the sale price of the first property.
Recent tax law has given us a few more opportunities. For example, there is a method of holding title to property called “tenants-in-common” in which there is more than one owner. While you can’t exchange an in-vestment property for an interest in a partnership even if the partnership owns real estate, you can exchange an investment property for a group ownership property if the property is held as tenants-in-common.
