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When we think about the term “like-kind” in section 1031 exchanges, think of it this way: It’s fairly simple to sort through most possibilities, but every case is unique and every case should receive an independent analysis.

 

How to Determine If Your Replacement Property Is Like-Kind and Eligible for a 1031 Exchange

Jun 05, 2017

The game 20 Questions has always been one of my favorites to play with friends. If you haven’t played it before, the game involves one “answerer” who responds to queries posed by the “questioners” about information the answerer is hiding.

What I love about the game is that it’s simple but always intriguing because it forces you to act as a detective. Usually, to figure out what’s being hidden, you need to eliminate possibilities by learning about the associations of whatever is hidden.

The game actually parallels the type of reasoning that is typically employed in law. Sometimes, to determine precisely what is encompassed in a given law, you need to methodically eliminate possibilities until you get a sense of how the law is interpreted. This isn’t always easy. Polar extremes are easy to account for, but from these extremes, things get increasingly blurry, and ultimately, there comes a point at which questions can only be settled on a case-by-case basis.

So when we think about what exactly is encompassed by the term “like-kind” in section 1031 exchanges, it’s beneficial to look at the issue in this way: It’s fairly simple to sort through most possibilities, but it’s important to remember that every case is unique and every case should receive an independent analysis. Let’s explore the contours of the term “like-kind” in detail by examining examples of properties that are not considered like-kind and by looking at the provisions of section 1031 more closely.

Personal Property Cannot Be Like-Kind to Real Property

Right away, we can strike out personal property as being ineligible as replacement property in 1031 exchanges. Section 1031 involves a transfer of interest in real estate, so the exclusion of personal property is perhaps the most intuitive statement we can make. Of course, the determination of whether a given property is real or personal is often a matter of state law. But if it is determined as personal, that property can never be considered “like-kind” to real property held for business or investment purposes (as required by section 1031).

Here’s a short list of common pieces of personal property (these will not qualify as like-kind):

  • Notes, stocks, bonds, or other financial instruments.
  • Interests in a partnership or LLC (with the exception of a single-member LLC that holds real property).
  • Certificates of trust.
  • Inventory.
  • Choses in action (rights to sue).

Whether some or all of these pieces of personal property could be included as boot on top of real property is dependent on the facts of a given case. For now, it’s enough to say that these common types of property could never function alone as like-kind real property.

Courts Have Included a Wide Range of Real Estate as Being Like-Kind Under Section 1031

Now that we’ve discussed property that cannot be considered like-kind, let’s explore the possibilities of what makes a property eligible as a replacement property in a 1031 exchange. In general, courts have interpreted the like-kind provision of section 1031 pretty broadly. This reflects the underlying goal of section 1031, which is to effect a transfer of interest in real estate held primarily for business or investment. This means that it is very possible to transfer an interest in real estate for another interest, even if the interests exchanged are not equivalent.

For instance, under section 1031, an easement (which is a right to use real property) has been held to be like-kind to a fee interest (which is a more substantial ownership interest than an easement). What’s more, tenancy-in-common interests (which are interests divided across multiple owners) have been held to be like-kind to a fee interest as well. Though these interests weren’t equivalent, there is enough of a transfer that the distinct properties are held to be like-kind for the exchange.

The table below shows a few more examples of replacement properties that have qualified as like-kind.

Replacement Property

Original Property

City real estate

Ranch or farm

Commercial buildings

Vacant lots

Condominium units

Fee interest

Mineral rights

Fee interest

 

In addition, remainder interests may be considered like-kind to a life estate provided that the life tenant has a life expectancy of at least 30 years.

These are just a few examples of types of property that have qualified as like-kind at different times under various jurisdictions. Again, one of the core points that you as an investor need to take away is that like-kind determination requires an individualized analysis. This is especially true when dealing with anything within the gray area between the extreme possibilities.

Importantly, the phrase like-kind is meant to refer specifically to the nature and character of the real property rather than its quality. So section 1031 holds that a newly improved piece of real property is regarded as like-kind to an unimproved piece of real property. Differences in quality may have ramifications for the exchange (as it may require boot), but these differences do not intersect with how the term like-kind is interpreted. Remember this key point: There does not have to be a transfer of equivalent interests in real estate for the transfer to involve “like-kind” interests. Equivalency is not a factor in determining like-kind status.

When it comes to ensuring a replacement property is eligible for a 1031 exchange, it’s important to remember that every individual situation is unique, and you should always seek assistance when you’re preparing to initiate your exchange. Luckily, CWS Capital Partners has a team of experts that can help you navigate the issues that come up with choosing a suitable like-kind replacement property. What’s more, we partner with you throughout the course of your 1031 exchange and ensure your investment is properly managed. Contact CWS Capital Partners today to learn more.

 

The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.

All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.

Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.

Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.


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