What Is Like-Kind Property in a 1031 Exchange?

Like-kind property in a 1031 exchange is real property held for business or investment use that shares the same general nature or character as another piece of real property, regardless of differences in grade, quality, or specific use. Under Internal Revenue Code Section 1031, swapping one qualifying property for another lets you defer the federal capital gains tax you would otherwise owe on the sale, until you eventually sell a replacement property for cash rather than exchanging it again.

What “Like Kind” Actually Means

The IRS looks at whether two properties share the same fundamental nature, not whether they look alike, cost the same, or serve the same purpose. Under Treasury Regulation Section 1.1031(a)-1(b), “like kind” refers to the broad category of property, not its specific grade or quality. A vacant lot and a fully developed office building are like-kind because both are real property. You could exchange a rural cattle ranch for an urban apartment complex and still qualify for tax deferral.¹

The focus is on the legal rights tied to ownership, not on the physical features of the land or buildings. A bare desert parcel and a downtown storefront with tenants sit in the same category. So long as both assets are legally classified as real property, they satisfy the like-kind standard.²

That breadth is the whole point. Investors are not locked into swapping like for like in any everyday sense of those words. Farmland for a strip mall, a warehouse for raw acreage, a single-family rental for a share of a commercial building — all of these can qualify under the same standard.

What Counts as Real Property

Treasury regulations finalized in 2020 spell out exactly what counts as “real property” for Section 1031 purposes. The definition covers three broad categories: land (including air space and water rights above it), improvements to land (buildings and other permanent structures), and unsevered natural products of land.³

Improvements to land include any “inherently permanent structure,” meaning a building or other structure that is permanently affixed and expected to remain in place indefinitely. That covers houses, apartment buildings, office towers, warehouses, factories, hotels, enclosed garages, bridges, roads, paved parking lots, cell towers, oil pipelines, grain silos, and similar infrastructure. Structural components of those buildings, such as HVAC systems, plumbing, and electrical wiring permanently installed in the structure, also qualify.³

Beyond physical structures, certain intangible interests also qualify as real property:

A leasehold interest with 30 years or more remaining is treated as like-kind to a fee interest in real property.²
Working interests, royalty interests, and overriding royalty interests in oil, gas, or minerals count as real property when the interest has an unlimited duration. A production payment that terminates once a set dollar amount is received does not qualify.
Air rights, water rights, conservation easements, and similar interests can qualify if they are recognized as real property under state or local law.³

Business or Investment Use Requirement

Being real property is only half the test. Both the property you give up and the property you receive must be held for productive use in a trade or business or for investment. This requirement sits in the statute itself and focuses on your intent at the time of the exchange and during your preceding ownership.⁴

Property held primarily for sale, such as a developer’s inventory of newly built homes, does not qualify. The distinction is between a long-term investor who holds property for rental income or appreciation and a dealer who buys and sells properties as a regular business. The same taxpayer who sells the relinquished property must acquire the replacement property; you cannot swap the identity of the taxpaying entity midway through.

Personal residences are excluded because they are used for personal enjoyment rather than business or investment. A vacation home that you never rent out generally fails the investment-use test as well. If the IRS recharacterizes a personal-use exchange as a taxable sale, you could face an immediate tax bill plus a 20-percent accuracy-related penalty on any underpayment.⁵⁶

Vacation Home Safe Harbor

A vacation home can qualify if it meets the safe harbor in Revenue Procedure 2008-16. The property must satisfy specific rental and personal-use limits for 24 months: the 24 months before the exchange for the property you give up, or the 24 months after the exchange for the property you receive. Within each 12-month period, you must rent the dwelling at fair market rent for at least 14 days, and your own personal use cannot exceed the greater of 14 days or 10 percent of the days the property was rented at fair rental.⁷

After meeting the 24-month safe harbor on a replacement property, you may convert it to a primary residence or full-time vacation home. An earlier conversion risks disqualifying the exchange.

What No Longer Qualifies

The Tax Cuts and Jobs Act of 2017, effective January 1, 2018, limited Section 1031 to real property only. Before that date, exchanges of personal property (equipment, vehicles, artwork, and other tangible business assets) could also qualify. That is no longer the case.¹

The following are now ineligible for a 1031 exchange:

Personal property, including construction equipment, vehicles, office furniture, machinery, artwork, collectibles, and patents.
Financial instruments such as stocks, bonds, notes, and other securities.
A direct interest in a partnership. Owning real property through a single-member LLC (which is disregarded for tax purposes) generally does not create the same problem.
Any real property held primarily for sale to customers rather than for long-term investment.⁴

If you complete an exchange with non-qualifying property and the IRS disallows it, the entire gain becomes taxable. The maximum federal rate on long-term capital gains is 20 percent, plus the 3.8-percent net investment income tax for higher earners, for a combined maximum of 23.8 percent.⁸

Geographic Limits

Real property in the United States is only like-kind to other real property in the United States. You cannot exchange a domestic property for foreign real estate, or vice versa; the statute treats them as entirely separate categories.⁴

If you hold foreign real estate and want to defer gain, the replacement property must also sit outside the United States. Foreign-to-foreign exchanges are permitted. What the law prohibits is crossing the border in either direction.

Some states also impose “clawback” provisions that require you to pay deferred state tax if you exchange property in that state for property located in another state. The specific rules and withholding rates vary, so cross-state exchanges deserve a check in both the original and replacement property states.

Related-Party Exchanges

Exchanges between related parties, meaning family members or entities where one party has significant ownership of the other, face an additional restriction. If either party disposes of the property received within two years of the last transfer, the deferred gain becomes taxable as of the date of that disposition.⁴

Three exceptions apply to the two-year rule: a disposition that occurs after the death of either party, a compulsory or involuntary conversion such as a government condemnation, and a transaction where you can establish that tax avoidance was not a principal purpose of either the exchange or the later disposition.⁴

The property may be like-kind and held for the right purpose, but if the parties are related and the two-year hold is broken without one of these exceptions, the deferral collapses. It is a qualification question dressed as a timing rule.

1
Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
2
eCFR. 26 CFR 1.1031(a)-1 – Property Held for Productive Use in Trade or Business or for Investment
3
GovInfo. 26 CFR 1.1031(a)-3 – Definition of Real Property
4
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
5
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
6
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
7
Internal Revenue Service. Revenue Procedure 2008-16 – Safe Harbor for Dwelling Units in Section 1031 Exchanges
8
Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed