The Art And Science Of Like-Kind Exchanges

Tax News You Can Use | For Professional Advisors

Jane Ditelberg, Director of Tax Planning

July 14, 2025

Investors and businesses are well aware of the tax rule that the sale of business or investment property results in a capital gain (or loss) on the transaction for tax purposes. Depending on how much the property is worth and its basis, a sale can generate a significant tax, which serves as a disincentive to sell some assets. A sale does not necessarily have to involve cash — if the buyer gives the seller a boat, a car and a washing machine in exchange for an airplane, a gain or loss occurs for the seller in the same way as if the buyer paid cash.

An exception to this rule is “like-kind exchange” treatment, where one item of qualified business or investment property is traded for another asset of the same nature, character or class. Under Section 1031 of the tax code, when a taxpayer completes a like-kind exchange, the taxpayer can defer the gain that would have been recognized upon a sale of the first or original property until a sale or exchange of the replacement property. There are several ways to implement a like-kind exchange, even if the buyer who wants a taxpayer’s assets does not own property to exchange. However, there are extensive requirements for what type of property is eligible for a like-kind of exchange, the characteristics that determine if the replacement property is like-kind, when the elements of the exchange must take place, and how the transaction is reported to the IRS. When a like-kind exchange occurs, the seller’s basis in the original property is carried over and becomes the basis of the replacement property.

What Type Of Property Qualifies For Section 1031 Exchange Treatment?

Although we often hear about like-kind exchanges of real estate, not all real estate is eligible for Section 1031 treatment, and like-kind exchanges are not limited to real estate. The first requirement for Section 1031 treatment is that the property is business or investment property. This means that a personal residence, for example, does not qualify for a like-kind exchange, and neither does inventory. Stocks, bonds, limited partnership or LLC interests, other securities, certificates of trust, notes and other debts are other types of property that are ineligible for like-kind exchange treatment. The rule applies to both the original and the replacement property and relates to their use by the seller.

What Qualifies As Like-Kind Property?

One of the reasons we see so many like-kind exchanges involving real estate is that most real estate investment property is treated as like-kind to any other real estate investment property. This means the seller of a commercial property can acquire a farm or an apartment building in a like-kind exchange. On the other hand, for personal property, the degree of likeness required is higher. For example, a business cannot use a like-kind exchange to trade a business-use car for a truck.

Can Related Parties Execute A Like-Kind Exchange?

Additional rules apply when a like-kind exchange involves related parties, but it is possible. It cannot be done as a tax-avoidance scheme, and each of the related parties must retain the property received in the exchange for a minimum of two years following the exchange.

How Is A Like-Kind Exchange Structured?

There are three ways to structure a like-kind exchange under the tax code. The simplest is a direct exchange. Sometimes the person who acquires the taxpayer’s property has other property the seller would like in exchange. In this circumstance, a direct exchange is possible. More often, an exchange is indirect, with the seller finding replacement property owned by a third party. In this case, the buyer pays the money through a conduit to the third party, the original seller ends up with the property of the third party, and the buyer ends up with the seller’s property. There are two other routes to do an exchange — a deferred like-kind exchange, where the funds from the sale are put in escrow and the seller then identifies and purchases a property from a third party, and a reverse exchange, where the purchase occurs first.

Simultaneous Direct Like-Kind Exchange

If the two parties to a proposed exchange each have qualifying like-kind property, they can do a direct exchange with a simultaneous closing. There is no intermediary — the properties are exchanged at one time, and the like-kind exchange is reported to the IRS along with any other consideration that changes hands if the properties do not have the same value.

Example 1:

Among Doris’ assets at her death in 2020 were four parcels of commercial real estate, each valued at $5 million. Her will created two trusts: One trust is for the benefit of her children and the other is for the benefit of her husband, Hugh. A 75% undivided interest in each property was transferred to Trust A for Hugh, and the remaining 25% was transferred to Trust B for Doris’ children. In 2025, when each of the four parcels is worth $10 million, the trustee of Trust A proposes a like-kind exchange with Trust B, where Trust A would transfer its 75% undivided interest in Parcel 1 to Trust B in exchange for Trust B’s 25% interest in each of Parcels 2, 3 and 4. This exchange would be a direct like-kind exchange. The following chart illustrates how it works.

In the end, Trust B would own 100% of Parcel 1, with a value of $10 million and basis of $5 million. Trust B would own 100% of each of Parcels 2, 3 and 4, with a value of $10 million per property and a basis of $5 million per property. There is no change in each party’s total basis, although the gain is deferred until such time that the properties are sold, as long as each side holds the new interests for at least two years, since they are related parties. If Parcel 1 was worth less than Parcels 2, 3 and 4, then Trust A would have to pay additional compensation, often referred to as “boot,” to Trust B for the transaction. In that case, Trust B would recognize a gain on the additional amount paid. It is critical that the cash or other property not be received before the exchange property: For this reason, it is helpful to use a facilitator for an exchange — even in direct swaps.

Deferred Like-Kind Exchange

A deferred like-kind exchange is a more complex transaction and reflects the fact that sometimes it takes more than two parties to put together a like-kind exchange transaction. Generally, intermediaries or facilitators are used to structure a transaction, and the documentation can be complex. To be an intermediary for this type of transaction, the person or entity must be independent and cannot have worked for the taxpayer as an agent, attorney, accountant, investment banker, broker, or employee in the preceding two years. Most importantly, there are two strict deadlines that must be met for a transaction to qualify as a like-kind exchange: The seller must identify the replacement property they intend to acquire in the exchange within 45 days of the first transfer, and they must complete the swap by the earlier of 180 days after the first transfer or the due date for the income tax return for the year in which the first transfer occurred.

Replacement property is identified by giving written notice to another party to the transaction that describes the replacement property and indicates an intent to complete the exchange for that property. Note that the notice must be provided directly to another party to the transaction, such as the seller of the replacement property or the qualified intermediary — it is not sufficient to provide notice to the taxpayer’s attorney, accountant or other agent.

Example 2:

Eduardo is thinking of diversifying his real estate investment portfolio, which currently consists of several commercial properties. He wants to add multi-family residential property to his portfolio. His basis in his investments is quite low, having held them for a long time, so he would like to do a like-kind exchange and defer the gain. Brenda is interested in buying one of Eduardo’s commercial properties with the proceeds from the sale of her business, but she does not own any real estate investments she can swap with Eduardo. Meanwhile, Eduardo learns Sara is looking to shift some of her investments from real estate to private equity. Sara inherited a residential apartment building from her mother last year, so her basis is high compared to the value of the property, and she would like to receive cash so she can reinvest. Sara is not interested in trading her apartment building for Eduardo’s strip mall.

Enter Irene. Irene is a qualified intermediary and works at putting together deals for parties interested in like-kind exchanges. She proposes a three-way trade, where Eduardo exchanges his commercial property for Sara’s apartment building, Sara exchanges her apartment building for Brenda’s cash, and Brenda exchanges her cash for Eduardo’s commercial property. To accomplish this, Eduardo has to identify Sara’s apartment building as his replacement property in writing within 45 days of signing the contract with Brenda for her to acquire his property, and the entire transfer must be completed within 180 days or by the due date for Eduardo’s tax return, whichever is earlier.

The contractual documentation is complex, but, essentially, Irene has each party put their property in escrow with her. She completes the documentation to ensure that Eduardo receives the apartment building, Brenda receives the strip mall, and Sara receives the cash. Eduardo does not recognize gain on the sale of his strip mall, and the basis of the apartment building in his hands is the basis he had in the strip mall at the time of the transaction.

Reverse Exchange

A reverse exchange is similar in principle to a deferred exchange. The difference is that instead of Eduardo identifying Brenda as the buyer for his property first, he identifies Sara’s property as one he wants to buy first. Irene, as the intermediary or facilitator, takes title to the apartment building first and then the exchange is worked out, also within the 180-day period. While a deferred exchange can be accomplished without an intermediary if planned carefully, it is exceedingly difficult to complete a Reverse Exchange without a qualified intermediary.

Impact Of Debt

It matters if there is debt secured by the property at the time of the exchange. If Eduardo’s strip mall had a mortgage on it, and the property he acquires in the exchange does not, Eduardo is treated as having received additional proceeds in the exchange and will pay capital gains tax on that amount. On the other hand, if there is debt on the property acquired in the exchange that is equal to or greater than the debt on the original property, no gain is recognized.

Reporting Requirements

A taxpayer reports a like-kind exchange by filing IRS form 8824. See 2024 Form 8824.