What is Like Kind Exchange? "Like kind exchanges" are exchanges of property for the same kind of property. This is the most common kind of exchange that is nontaxable under the Internal Revenue Code. Like kind exchanges are not just for the wealthy taxpayers. Many taxpayers find themselves running into, or at least facing, the concept of like kind exchanges.

What is Like Kind Property? The primary determination in any like kind exchange is whether the property given up is the same kind as the property received. For example, if a property is real estate, one must exchange real estate for new real estate for this to be considered a like kind exchange.

An Illustration of the Like Kind Rules in Action:

Assume you have an investment house worth $200,000. You trade your house for another property to be held as an investment worth $200,000. You have no gain or loss, and the like kind exchange rules would apply, assuming no other Tax Code provisions are applicable. Under the normal rules of the Tax Code, if you simply sold the original house, you would have to pay taxes on the difference between the selling price of the house and the adjusted basis [cost] after subtracting your selling costs also. The purchase of the second house would have no tax consequences until that property was later sold. You can see there can be tremendous tax advantages if a transaction falls within the like kind exchange rules.

You might also be able to see that if your determination is wrong, the tax consequences can be huge. Thus, it is recommended that this area be handled only with professional advice.

The Nature of the Property is Determinative Under the Internal Revenue Code, the nature of the property is what is used to determine whether the property meets that "like kind" designation. The value or quality of the property may not be determinative. Because property can be exchanged for like kind property, but at different values, a taxpayer can engage in serious tax planning to determine the best tax consequences when contemplating such an exchange. Professional assistance would be helpful, however, since the issues are complicated.

Qualifying Property is Required Additionally, there is the requirement in the Internal Revenue Code that the property must be "Qualifying Property." This means that both the property you give up and the property received must be held as either an investment or for productive use in a trade or business. While there are many business or trade rules beyond the scope of this discussion, this issue usually surfaces when an individual taxpayer owns a second home and they are considering selling it. Sometimes, if one can obtain a definitive opinion, it may make sense to exchange this second house property for another like kind property, instead of selling it, and creating a huge tax liability.

Also, while many people think of the like kind exchange in the context of real property, it can be other personal property, such as vehicles.

Factors Required for Exchange to Be Nontaxable There are at least six factors that must be present in a like kind exchange to render such an exchange nontaxable to the taxpayer. These factors are:

• Business or investment property
• Property not held primarily for sale
• Property must not be stocks, bonds, notes, or other specified property
• Trade of like kind property
• Property to be received must be identified within 45 days after transfer of property given up
• Property must be received within time limits of code (180 days or due date, including extensions of taxpayer's tax return.)

These are set forth in the Tax Code, and court cases are numerous in providing guidance as to whether these factors have been met. One should review the Tax Code and court cases for a full analysis of these factors, since serious tax liability may result if the 1031 exchange is not held to be nontaxable.