In order to complete a Section 1031 Exchange, both the sold ('Relinquished') property and the acquired ('Replacement') property must qualify as ‘like-kind’ pursuant to the guidelines set forth in the IRS Regulations.  The like-kind rules for real estate exchanges and personal property exchanges are set forth below. 


Like-kind Requirements for Real Estate Exchanges

The like-kind requirement for real property exchanges is fairly easily satisfied.  To qualify for a Section 1031 Exchange, all properties in the exchange must initially meet these standards:

1.  Properties must be defined as real property under applicable state law.  Many taxpayers associate Section 1031 Exchanges with fee interests, however many other real property interests also may qualify.  These includes tenant in common interests in qualifying real property, also conservation easements, perpetual water rights, and co-op interests.  The like-kind test for these non-fee interests is that they must be considered a real property interest by the law of the state in which the property or interest is located. 

 

2.  Properties must be ‘used in a trade or business, or held for investment.’  As a general rule, this includes most properties that are rented or leased to a tenant at a fair market value rental.  This definition excludes property with significant personal use, and property that is ‘held for sale’ or ‘acquired for resale,’ often referred to as ‘inventory’ or ‘dealer property.’   

 

In February, 2008, the IRS released Revenue Procedure 2008-16, which is effective for exchanges occurring on or after March 10, 2008.  Rev. Proc. 2008-16 establishes a ‘safe harbor’ under which the IRS will not challenge whether or not a dwelling unit meets the qualifying use requirement.  To meet the safe harbor guidelines, the ‘Relinquished’ property must meet the following requirements:

 

a. The property must be owned by the taxpayer for at least 24 months immediately prior to the exchange; and

 

b. In each of the two 12-month periods prior to the beginning of the exchange, the taxpayer must have rented the property to another person for 14 days or more at a rental equal to the property's fair market value; and

 

c.  In each of the two 12-month periods prior to the exchange, the taxpayer’s personal use of the property must not have exceeded the greater of (i) 14 days; or (ii) ten percent of the number of days the property was rented at its fair market value.

 

The ‘Replacement’ property in the exchange must meet similar requirements in order to meet the safe harbor requirements of Rev. Proc. 2008-16:

 

a. The property must be owned by the taxpayer for at least 24 months immediately following the exchange; and

 

b. In each of the two 12-month periods immediately after the exchange, the taxpayer must rent the property to another person at its fair market value; and

 

c.  In each of the two 12-month periods immediately after the exchange, the taxpayer’s personal use of the property must not exceed the greater of (i) 14 days; or (ii) ten percent of the number of days the property is rented at its fair market value.

 

Please remember, Rev. Proc. 2008-16 establishes a safe harbor for properties in a 1031 exchange to meet the ‘qualifying use’ guidelines.  Failure to meet the safe harbor requirements does not necessarily disqualify a property for a Section 1031 exchange.  It is advisable for property owners interested in an exchange to review their facts and circumstances with a tax advisor, if their ownership and use of a property does not meet the safe harbor guidelines. 

 

 

3.  Properties located within the 50 States, the District of Columbia, and the US Virgin Islands are considered like-kind with other properties so located.  Properties located outside of these regions are considered like-kind with other properties that also are located outside of these regions.
 

Please note the flexibility provided by Section 1031 to owners of real property.  The like-kind requirements allows you to exchange, for example, land for a multi-family rental unit, an apartment building for an office building, a retail property for an industrial property, undeveloped land for a rental property in a resort area.   

You are welcome to contact the professionals of Beacon Exchange Company if you would like more information regarding the like-kind requirement for real property exchanges.

 

 

Like-kind Requirement for Personal Property Exchanges

 

Like-kind exchanges are an effective investment strategy for many categories of personal property, including but not limited to aircraft, vessels, and intangible assets.  While the range of real property exchanges that can satisfy the ‘like-kind’ requirement is fairly broad, the rules are more rigorous for personal property exchanges.  The regulations state that personal property will meet the like-kind requirement if it is of the same general asset class or the same product class.  In addition, the requirement can be met if the assets are deemed to be of like kind under general principles.  

  

Same General Asset Classes 

 

Properties are of like class if they are within the same General Asset Class described in asset classes 00.11 through 00.28 and 00.4 of IRS Revenue Procedure 87-56 as supplemented.  This IRS document classifies properties for depreciation purposes and groups various sorts of tangible personal property in a series of General Asset Classes.  For example, office furniture, fixtures and equipment are included in one General Asset Class while vessels and barges grouped in another General Asset Class.  Similarly, all automobiles fall into the same General Asset Class and light trucks form a separate Class. 

Same Product Classes 

Properties are also of like class (and therefore satisfy the like-kind requirement) if they fall within the same "Product Class." However, the like-kind requirement may not be satisfied by reference to Product Class if the property is set forth in a General Asset Class.  The Product Class status of property not listed in a General Asset Class is determined by referring to the 6-digit product class within Sectors 31, 32 and 33 of the North American Industrial Classification System ("NAICS").  

  

Like-Kind Determination for Other Assets 
 

Certain assets, such as licenses, franchises, and other intangible personal property, do not belong to either a General Asset Class or a Product Class. Such property may, nonetheless, satisfy the like-kind requirement.  Under the regulations, the determination of whether non-classified property is generally of like-kind is made based on all of the facts and circumstances. IRS Reg. § 1.1031(a)-2(c)(1).

 

The facts and circumstances test will also apply if one asset is described in the General Asset Class and the other asset is found in the Product Class.  One example of such a situation is an aircraft used for corporate business purposes and a charter aircraft, which might be the case in an Aircraft Exchange.
 

 

Foreign Use Property 
 

Personal property used predominantly within the US is not considered like-kind with personal property used predominantly outside the US.  If you have assets that may be affected by these rules, please contact us.

 
 

Summary

 

While the like-kind requirement is fairly easily satisfied for real property, there is a narrower range of properties that will be treated as being like-kind in personal property exchanges.  Remember, too, that property located in the 50 State, the District of Columbia, and the US Virgin Islands will meet the like-kind requirement with other property so located, while property in other jurisdictions will not. 

 

Please contact us if we can provide any additional information for you regarding the like-kind requirements for real property or business equipment.