Like-Kind Property Explained

Like-kind property is the foundational requirement of a 1031 exchange, and its definition today is both broader and narrower than many investors expect. Following changes to the federal tax code effective in 2018, Section 1031 applies exclusively to real property, meaning land and anything permanently affixed to it, that is held for productive use in a trade or business or for investment. Personal property exchanges, which were once permitted for equipment, vehicles, artwork, and similar assets, no longer qualify for like-kind exchange treatment at all, regardless of how similar the assets being traded may be.

Within the category of real property, however, the definition of like-kind is remarkably broad. The Internal Revenue Service has long held that essentially all real property held for investment or business use is like-kind to essentially all other real property held for investment or business use, regardless of grade or quality. This means an investor in Jacksonville can exchange raw, unimproved land for a fully leased industrial warehouse, or exchange a retail strip center for a multifamily apartment complex, or exchange a single tenant net lease property for a fractional interest in a larger commercial asset, and each of these pairings satisfies the like-kind requirement, because the comparison is based on the nature of the property right, not the specific use, condition, or property type.

The critical qualifying condition is not the type of real estate but the purpose for which it is held. Property must be held for investment or for use in a trade or business on both ends of the exchange. This immediately excludes a personal residence, a vacation home used predominantly for personal enjoyment rather than rental, and property held primarily for sale, which is the category that covers property flippers and developers who build or renovate property with the specific intent to sell it quickly rather than hold it for income or appreciation. An investor who has been renting out a duplex in Riverside or San Marco for several years and now wants to exchange into a larger multifamily property in Mandarin or the Southside is well within the intended use of Section 1031, while a builder who constructs and sells homes as inventory generally is not.

Geography matters as well. Real property located within the United States is not considered like-kind to real property located outside the United States. An investor selling commercial property in Duval County cannot use exchange proceeds to acquire property in another country and still qualify for deferral under Section 1031, even though both are real property held for investment.

Vacant land presents a common question in the Jacksonville market given ongoing development activity along growth corridors in St. Johns and Clay counties. Raw land held for investment or future development qualifies as like-kind to improved, income-producing property, and vice versa, since both are real property held for investment purposes. What matters is documenting the intended use and holding period, since the Internal Revenue Service and courts look at the facts and circumstances surrounding how the property was actually used, not simply how it was labeled on paper.

Because the like-kind standard turns on how property has been held and used rather than on property type, we help investors document their holding history and intended use for both the relinquished and replacement property before a transaction moves forward, so there is a clear record supporting qualification if the exchange is ever reviewed.

Mixed-use property presents a more nuanced version of the like-kind question that comes up regularly in the Jacksonville market. An investor who owns a building with ground-floor retail and upper-floor residential rental units, or a property that includes both business use and a portion used personally, such as an owner-operator's business location, needs to separate the qualifying business or investment use from any personal use portion when structuring an exchange. Only the value attributable to the investment or business use portion qualifies for exchange treatment, so an accurate allocation, often supported by an appraisal or cost segregation analysis, is an important step before listing a mixed-use relinquished property or making an offer on a mixed-use replacement property.

Timing of intended use also matters for property recently converted from personal to investment use, or vice versa. An investor who recently moved out of a property and began renting it, or who is planning to convert a rental property to personal use shortly after an exchange, should understand that the Internal Revenue Service and courts look at the investor's intent and actual use both before and after the exchange. While there is no statutory bright-line holding period written into Section 1031 itself, common practice among tax professionals is to hold both the relinquished and replacement property for a meaningful period, often cited as at least one to two years, with clear evidence of investment or business use, such as lease agreements and reported rental income, to support the position that the property was genuinely held for investment rather than acquired with an intent to quickly convert it to personal use.

Entity structure adds another layer worth confirming before an exchange begins. The taxpayer that sells the relinquished property generally must be the same taxpayer that acquires the replacement property, meaning an investor who owns a Jacksonville property individually cannot sell it and have a different entity, such as a newly formed limited liability company with different ownership, acquire the replacement property and still qualify for full deferral, absent specific structuring such as a single-member disregarded entity that is treated as the same taxpayer for federal tax purposes. We review entity ownership on both sides of a transaction early, since restructuring ownership after a relinquished property is already under contract is far more difficult than confirming the correct structure before listing the property.