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This blog post was written by George Ratiu, Director of Quantitative & Commercial Research and Erin Fitzpatrick, Research Intern.
For a significant proportion of real estate market participants, like-kind exchanges (LKE) provide an important vehicle to sell and acquire property. The Internal Revenue Code (IRC) Section 1031 codifies that the tax owed on any gain after a sale may be deferred as long as the proceeds are reinvested in a similar property through a like-kind exchange.
According to the IRS, “like kind property is property of the same nature, character or class. […] Most real estate will be like-kind to other real estate.”[1] Generally, a parcel of land with a rental house may be exchanged for vacant land. Similarly, an office building may be exchanged for an industrial warehouse or a retail shopping center. The IRS makes exception with real properties located outside the United States, noting that domestic U.S. real estate may not be treated as like-kind to international real estate.
Like-kind exchanges are available to individuals, partnerships, corporations, limited liability companies, as well as trusts. While the general assumption may be that mostly large real estate investors benefit from LKEs, the data reveal that like-kind exchange transactions are intensively employed by small businesses, comprising an integral component of their real estate activities.
The Like-Kind Exchanges: Real Estate Market Perspectives 2015 report—based on a survey of over 100,000 REALTORS®—highlights the importance of LKEs to small businesses. REALTORS® were asked about the composition of business entities which held the properties transferred through a like-kind exchange. The survey results show that 48 percent of the total fair market value of exchanged properties was held in an individual or sole proprietorship. Close to half of LKE transactions in REALTORS’ markets occurred between small investors. The survey results indicate that 33 percent was held in a S-Corporation, Partnership, LLC, LLP, or MLP. An additional 10 percent of properties were held in C-Corporations (which excluded REITs).
[1] Internal Revenue Service, Like-Kind Exchanges Under IRC Code Section 1031, FS-2008-18, February 2008