Like Kind Does Not Mean Similar

Ask an owner what they can buy with a 1031 exchange and you will usually hear some version of the same answer. I sold apartments, so I have to buy apartments.

That is the single most common misconception in this whole area, it costs people good options every year, and it is wrong.

Like kind refers to the nature of the property, not its type, quality, grade or use. Almost all real property held for investment or productive use in a trade or business is like kind to almost all other real property held for the same purpose. Not similar property. Almost any property.

This article sets out what that actually permits, and the four categories it genuinely excludes. It is educational only and is not tax or legal advice. Confirm your own position with your CPA and Qualified Intermediary before acting.

What you can actually exchange into

If you sold investment real estate, all of the following are like kind to it:

• ›Raw land, exchanged for an apartment building.
• ›An apartment building, exchanged for a medical office.
• ›A single rental house, exchanged for a share of an industrial portfolio.
• ›A retail strip, exchanged for self storage.
• ›A farm, exchanged for a warehouse.
• ›A long leasehold interest with thirty years or more remaining, exchanged for a freehold interest, and the reverse.

None of these are exceptions or edge cases. They are the ordinary operation of the rule. The property you buy does not have to resemble the property you sold in size, type, location, quality or how it is used.

There is also no requirement to buy one property. You can sell one building and buy three, or sell three and buy one, provided the identification rules and the value and debt tests are satisfied.

Where a DST fits

This matters because of a specific piece of guidance. Under IRS Revenue Ruling 2004-86, a beneficial interest in a properly structured Delaware Statutory Trust is treated as a direct interest in real property for these purposes.

So a DST interest is like kind to the building you sold, in the same way another building would be. That is the entire reason DSTs exist as a 1031 option rather than being a merely interesting structure. The same applies to a properly structured Tenants in Common interest.

It is worth being clear about what this does not mean. The interest qualifies as like kind, but DST interests are securities offered to accredited investors only, through a licensed broker dealer and definitive offering documents. Qualifying under section 1031 and being available to you are two separate questions.

The four things that are genuinely excluded

The rule is wide, but it is not unlimited. These are the categories that do not work.

Your home. A primary residence is not held for investment or business use and does not qualify. That is dealt with by a different provision, section 121, which is the exclusion most people know as the home sale exemption. A property that was once your home and has since been a genuine rental is a more complicated question and one for your CPA rather than an article.

Property held primarily for resale. If you buy, refurbish and sell in a short period, the IRS may treat that property as inventory rather than an investment, and inventory does not qualify. There is no bright line number of months that makes this safe. It turns on your intent and on the pattern of your activity, which is why anyone doing this repeatedly should take advice before assuming an exchange is available.

Foreign real estate. Property in the United States and property outside it are not like kind to each other. You cannot exchange a building in Texas for one in Portugal. You can exchange foreign property for other foreign property, which is of limited comfort to most people.

Anything that is not real property. Before 2018 the rules covered a range of personal property including equipment, vehicles, aircraft and collectibles. The Tax Cuts and Jobs Act removed all of that. Since then section 1031 applies to real property only. If you read older material describing an exchange of machinery or artwork, it is out of date.

Why this changes what you should be looking at

Once you accept how wide the rule is, the question changes shape entirely.

It stops being where do I find another building like the one I sold and becomes what do I actually want to own for the next ten years. Those are very different questions, and only the second one is worth spending your 45 days on.

An owner selling a tired apartment block in a market they have gone off is not obliged to find another tired apartment block. They can move into medical office, into industrial, into a different region entirely, or out of active management altogether. The tax rule is not what is constraining them. Their assumption about the tax rule is.

That assumption also causes a specific and avoidable failure. Someone convinced they must replace like with like searches a narrower market, finds less, identifies fewer properties, and is more exposed when a deal falls through after day 45. Believing the rule is narrow makes a failed exchange more likely, not less.

What to do with this

• ›Before you identify, list what you would actually want to own, not what resembles what you sold. Then check whether it qualifies, which it very probably does.
• ›Ask about asset classes you have never owned. Medical office, industrial and self storage behave differently from residential and may suit you better at this stage than another version of what you have just left.
• ›Use all three identification slots, and use them across different asset types rather than three variations of the same thing. Concentration is a choice, not a requirement.

The short version

Like kind is about the nature of the property, not its type. Nearly all investment real property in the United States is like kind to nearly all other investment real property in the United States, and a properly structured DST interest counts as well. What is excluded is your home, property held for resale, foreign real estate and anything that is not real property at all.

If you have been searching for a building like the one you sold, you have been looking at a fraction of what is open to you.

Want to see what is actually available across every asset class? Download the current property list and a licensed specialist will show you the options open right now, including the ones that look nothing like what you sold. Free, and no obligation.

About this article. 1031Property is an independent information and referral service. We are not a broker dealer, a Qualified Intermediary, a tax adviser or a law firm, and we do not sell securities or property. Nothing here is tax, legal or investment advice. Delaware Statutory Trust interests are securities offered to accredited investors only through a licensed broker dealer and definitive offering documents, and investing involves risk including the loss of principal. Confirm your own position with your CPA and Qualified Intermediary.