What is a Like-Kind Property?
Like-kind property is property that, for tax purposes, is similar in nature to property being sold. Like-kind property is a key component of Section 1031 exchanges, which are real estate transactions in which the buyer and seller effectively swap properties in order to avoid paying capital gains tax on the sale.
How Does a Like-Kind Property Work?
Let's assume John Doe wants to sell his commercial property for $600,000, which he bought for $400,000 as an investment. He knows that selling his property will generate a $200,000 gain that is taxable.
If John does a Section 1031 exchange, he can defer this capital gains tax by replacing the property with a “like-kind” property -- another property that is similar in nature to the one he is selling. However, if John sells his property and more than 45 days goes by without obtaining a replacement property, John may be subject to the capital gains tax, as well as a state capital gains tax. To speed things up and ensure compliance, he can contact a qualified intermediary and make a qualified exchange accommodation arrangement. The qualified intermediary is similar to an escrow company: It will transfer John's property to the buyer and transfer the replacement property to John.
By using a qualified exchange accommodation arrangement, an 'accommodation party' holds John Doe's property temporarily (or it can hold the replacement property temporarily). It is named as principal in the sale of the property and the later purchase of the replacement property.
Why Does a Like-Kind Property Matter?
Exchanges of like-kind property basically allow investors to defer a capital gain or loss on the sale of real estate. By using a qualified exchange accommodations arrangement, an investor is able to avoid touching the proceeds from the sale of a property before the proceeds are reinvested, thus helping avoid paying any capital gains taxes and assisting in the transaction.