Like Kind Property Explained

Like kind is the standard that determines which properties can be exchanged under Section 1031 while deferring tax on the gain. For Chicago, IL investors, the term sounds like it should mean similar properties, such as trading one apartment building for another apartment building of the same size, but the actual legal standard is far broader. This guide explains what like kind actually means for real property, what changed after the Tax Cuts and Jobs Act, and common misunderstandings that trip up first time exchangers.

Like Kind Means Nature and Character, Not Grade or Quality

Under the regulations, like kind for real property refers to the nature or character of the property, not its grade, quality, or use. This means a Chicago, IL investor can sell a piece of raw land and acquire an income producing apartment building, or sell an industrial warehouse and acquire a retail strip center, and both transactions can qualify as like kind, because all of these are real property held for investment or business use. The distinction that actually matters is whether the property is real property versus personal property, and whether it is held for investment or productive use in a trade or business versus held primarily for personal use or as inventory for resale. A property flipped for quick resale, for example, generally does not qualify because it is treated as inventory rather than property held for investment.

Real property located anywhere within the United States is generally considered like kind to any other real property located anywhere within the United States. A Chicago, IL investor selling a multifamily property in Illinois can exchange into an industrial property in Texas, a retail center in Florida, or a piece of raw land in Colorado, and the geographic difference does not affect like kind status. Real property outside the United States is not like kind to real property inside the United States, so investors considering a foreign replacement property need to understand that a US relinquished property cannot be exchanged into a foreign replacement property under Section 1031.

What Changed After the Tax Cuts and Jobs Act

Before 2018, like kind exchange treatment was available for a wider range of assets, including certain personal property such as aircraft, equipment, and vehicles used in a business. The Tax Cuts and Jobs Act eliminated 1031 treatment for personal property entirely, effective for exchanges completed after December 31, 2017, and limited Section 1031 to real property only. This means Chicago, IL investors selling a property that includes significant personal property, such as a hotel sold with furniture and equipment, or an apartment building sold with appliances that are treated as personal property under local law, need to separate the real property and personal property components of the sale, since only the real property portion is eligible for deferral.

Certain interests short of full ownership can also qualify as like kind real property, including leasehold interests with thirty years or more remaining, including renewal options, undivided fractional interests in real property, and certain water rights, mineral rights, and easements depending on how they are treated under state law. Chicago, IL investors considering an exchange into a less conventional interest, such as a long term ground lease or a fractional ownership structure like a Delaware Statutory Trust, should confirm the specific interest qualifies as like kind real property before relying on it to complete an exchange, since the analysis can turn on details of how the interest is structured and documented.

Chicago, IL investors frequently ask whether trading between very different real estate sectors, for example exchanging a downtown office condominium for a suburban industrial building near an intermodal rail yard, raises any like kind concerns. It generally does not, because the like kind standard for real property looks at whether both assets are real property held for investment or business use, not whether they share the same tenant type, market sector, or physical characteristics. This flexibility is a major planning advantage for investors repositioning a portfolio away from a declining asset class, such as aging suburban office space, and into a sector with stronger fundamentals, such as industrial or multifamily, all within a single tax deferred transaction, as long as both properties remain real property held for investment or business use rather than personal use or resale inventory.

Illinois investors should also be aware that the like kind determination for federal tax purposes generally controls how Illinois treats the transaction for state income tax purposes as well, since Illinois generally follows the federal treatment of 1031 exchanges rather than applying a separate state specific like kind standard. This means a Chicago, IL investor who structures a valid federal exchange typically does not need to separately requalify the transaction under a different state test, though the flat Illinois income tax rate still applies to any gain that is not deferred, such as boot received in the transaction. Investors moving into or out of Illinois entirely as part of an exchange, for example selling Chicago property and buying replacement property in another state, should still confirm with a tax advisor how the destination state treats any future disposition of the replacement property, since state rules on exchanges and subsequent sales vary.