Like Kind in Practice: Eight Exchanges That Surprise People

Most people learn about like kind property in the abstract: real property held for investment can be exchanged for other real property held for investment. The phrase is broad, but it only really sinks in through examples.

Here are eight situations that regularly surprise owners, some because they work and some because they do not.

1. Farmland into an apartment building

Works. Land held for investment is like kind to a residential rental building. A farming family that has held land for generations can exchange into income producing property without paying tax on the appreciation, provided the land was not held as inventory and the new property is held for investment.

2. A rental house into a share of an institutional building

Works. A single family rental can be exchanged into a fractional interest in a large apartment complex, industrial portfolio or medical office building through a Delaware Statutory Trust. DST interests are treated as interests in real property for exchange purposes. They are securities available to accredited investors only and carry illiquidity and costs.

3. An office building into vacant land

Works. The loss of rent and depreciation may make it a poor financial choice for some owners, but the tax rules allow it.

4. A warehouse into a long term leasehold

Often works. A leasehold interest in real property with 30 or more years remaining, including renewal options, is generally treated as like kind to a fee interest. Shorter leaseholds usually are not.

5. A US property into a property abroad

Does not work. Real property located in the United States is not like kind to real property located outside the United States. An owner cannot defer gain on a US rental by exchanging into a villa overseas, or the reverse.

6. Your home into a rental

Does not work under Section 1031 alone. A principal residence is not held for investment. A former home that has genuinely become a rental may qualify, and in some cases the home sale exclusion and a 1031 exchange can both apply to one sale, but the timing and facts matter.

7. Equipment and furnishings sold with a building

Does not work since 2018. Only real property qualifies. Furniture in a short term rental, equipment in a self storage facility, or machinery on a farm is personal property. Its value should be allocated separately, and gain on it may be taxable even when the building is exchanged successfully.

8. A partnership interest into a building

Does not work. Interests in partnerships and LLCs taxed as partnerships are specifically excluded. Partners who want different outcomes often need restructuring, such as converting to direct co ownership, well before a sale.

What is the underlying rule?

Two tests do most of the work.

Both properties must be real property. Land, buildings, certain permanent structures and qualifying interests in real property. Not equipment, securities or partnership interests.

Both must be held for investment or productive use in a business. Not a primary residence, not property held for resale as inventory.

Within those limits, the type of property generally does not matter. Improved for unimproved, residential for commercial, a single building for several buildings, or several for one.

What about state specific interests?

Some rights are treated as real property under state law, including certain water rights, mineral interests and air rights. Whether they are like kind to other real estate can depend on their permanence and how state law classifies them. These cases benefit from specialist advice.

Why does this matter when you are choosing replacement property?

Because the breadth of the rule gives you options. Owners who believe they must replace a rental with another rental often overlook alternatives that fit their stage of life better: net lease property with a single corporate tenant, land for long term appreciation, or passive fractional interests.

The right choice depends on income needs, management tolerance, liquidity and the time left in your exchange, not on the category of the property you sold.

How do exchanges with several properties work?

The like kind rule does not require one property for one property. You can sell one building and buy three, or sell three and buy one, as long as the identification rules are followed and the values work.

That flexibility is often used for two opposite goals. Owners consolidating toward retirement sell several small rentals and exchange into one net lease building or a few passive interests. Owners planning for heirs do the reverse, exchanging one large building into several smaller properties that can be divided among children.

Each relinquished property can even be sold at different times with separate exchanges, which can help when properties are not all ready to sell at once. The deadlines apply to each exchange separately.

Does the replacement have to be in the same state?

No. Real property anywhere in the United States is like kind to real property anywhere else in the United States. A California rental can be exchanged into a Texas warehouse or a Florida apartment building.

State tax rules may still follow you. California, for example, tracks gain deferred when property is exchanged out of the state and expects annual reporting. Check the rules of the state you are leaving before assuming the move is tax neutral at state level.

What to do first

List the property you are selling and what you actually want from the next one: income, appreciation, less work, diversification or something to leave to heirs. Then consider all the real property types that could deliver it, not just the one you know best. Confirm with your CPA that both sides meet the real property and investment tests.

Nothing here is tax, legal or investment advice. Classification of property depends on your facts and state law. Confirm your position with your advisers before acting.