Investing in real estate is a great way to diversify your investment portfolio and add physical assets to your holdings. It can also provide a hedge against inflation. For those who aspire to become real estate investors or already are, it’s essential to know about like-kind exchanges. These exchanges offer a chance to shift your real estate investments on a tax-deferred basis, helping you to have a dynamic real estate portfolio that you can adjust based on the market and economic conditions without incurring a large tax liability.

A like-kind exchange occurs when an investor sells real estate and buys another parcel that is similar to the one they sell, thereby avoiding the capital gains tax that would normally be assessed. This exchange is authorized as a Section 1031 exchange under the Internal Revenue Code (IRC). Both the like-kind exchange and like-kind property are defined under Section 1031.

Like-kind property is composed of real estate assets that are so similar in nature that they qualify for a like-kind exchange. The Internal Revenue Code defines a like-kind property as any held for investment, trade, or business purposes under Section 1031. The grade or quality of the assets is not used to determine like-kind property. Personal property cannot be used in a like-kind exchange. The gains of the transaction are not tax-exempt, but they are tax-deferred.

There are four types of like-kind exchanges: simultaneous, deferred, reverse, and improvement. Several conditions must be met for a property to qualify for an exchange. The property must be used in a trade, business or investment, and it must be like-kind to the property it is replacing.

When the replacement property is finally sold, that’s when the tax on the capital gain is paid. Only business or investment property can be exchanged as of the enactment of the Tax and Jobs Act of 2017. The exchange must be identical in nature, and the replacement property must be of the same or higher value. The owner of the original and replacement property must be the same person, and the property must be acquired in 45 days and the transaction closed in 180 days.

Real estate investors dealing in frequent real estate transactions should take advantage of like-kind exchanges when they can. Since real estate is usually like-kind for other real estates, the rules may not be as hard to follow as it appears. The most difficult issue may be the relatively short time frames to complete the acquisition and closing the deal.

Investors contemplating a like-kind exchange should carefully think through the pros and cons. That’s where a financial advisor can be invaluable. Contact us for an up-to-date vetted list of Qualified Intermediary, also known as 1031 exchange accommodator.

In conclusion, like-kind exchanges are an excellent tool for real estate investors to help them build a dynamic portfolio, adjust to changing market conditions, and defer taxes. By understanding the conditions and rules of these exchanges, investors can take advantage of them to maximize their investment potential.