A like kind exchange is an exchange of investment or business property that qualifies for non recognition of gain or loss. The main reason that the taxpayer does not have to recognize any gain or loss is because it is assumed that they will be in the same economic position after the exchange is completed.
Qualifying property for a like kind exchange must be held either for productive use, in a trade or business capacity or as an investment. The property exchange can be a mix and match though, this means that an investment property can be exchanged for a business property and the exchange will still qualify as like kind.
Property that is held for personal use is not considered eligible for non recognition; however, if the property is held for both business and personal use, the business part will qualify. Usually the part that is business use will have to be calculated as a percent of the property and that percentage will qualify for non recognition purposes.
Certain properties are excluded from like kind exchange treatment. These include stock in trade or other property help primarily for sale, stock, bonds, notes, or other securities. Transfer of partnership interests foes not qualify under the tax free exchange provision. Also, livestock of different sexes is not like kind property.
Defining “Like Kind”
The words “like kind” specifically address the nature or character of the property and do not refer to its grade or quality. This is important because two properties can be significantly different in terms of their quality and still be considered like kind. An example of this would be exchanging a class C office building for a class A office building.
The exchange of real property for another real property will generally qualify for like kind exchange treatment. Examples include improved real estate for unimproved real estate, city real estate for a farm and other types of exchanges of this nature.
Personalty for Personalty
Like kind treatment also applies to the exchange of personalty for personalty. An important provision of this type of exchange is the fact that the property exchanged must be of like class to qualify. This means that the property must be in the same asset class as one another. Some of the business asset classes include:
1. Office furniture, fixtures, and equipment
2. Information systems such as computers and their peripheral equipment
5. Light trucks
6. Heavy trucks
An example that would not qualify as like kind for this provision would be the exchange of office furniture for a computer. Another example would be the exchange of a building for a machine. Both of these examples would not qualify as like kind and therefore would not be eligible for non recognition of gains and losses.