8665 / What exchanges of property qualify as like-kind exchanges and are therefore eligible for nonrecognition treatment?

Editor’s Note: The 2017 tax reform legislation limited the nonrecognition treatment provided under IRC Section 1031 to exchanges of real property that is not held primarily for sale.¹ This provision applies to exchanges occurring after December 31, 2017. An exception exists if either (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.² The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.³IRC Section 1031(a) provides that no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a “like-kind” to be held for productive use in a trade or business or for investment.⁴ IRC Section 1031 does not provide a permanent exclusion of gain or loss because the taxpayer’s basis in the property exchanged transfers to the exchanged property, becoming the basis of that property.⁵ So if the taxpayer subsequently sells the replacement property, the deferred gain or loss would be recognized.

The phrase “like-kind” refers to the nature or character of the property and not to its grade or quality.⁶ So, whether real property is improved or unimproved is not relevant because virtually all types of real property are deemed to be of the same nature or character. Perhaps for this reason, the Section 1031 nonrecognition provision has been frequently used in connection with exchanges of real property and, under the 2017 tax reform legislation, is now limited to real property exchanges. Interestingly, the regulations provide that a leasehold interest with at least 30 years to run is equivalent to an ownership interest in real property.⁷

Prior to the 2017 tax reform legislation, only certain types of property were eligible for nonrecognition treatment under the rules applicable to like-kind exchanges. Exchanges of stock in trade (or other property held primarily for sale) and stocks, bonds, notes, and other securities or evidences of indebtedness or interest were specifically excluded under Section 1031, even though they might otherwise have qualified as business or investment property.⁸ Additionally, IRC Section 1031(h) specifically excluded exchanges in which at least one of the properties is real property located outside the United States (the 2017 tax reform legislation specifically provides that real property located within the U.S. and foreign real property are not of a like-kind). Similarly, an exchange involving a partnership interest in a real estate partnership is specifically excluded from like-kind exchange treatment.⁹