A like kind exchange is also known as a 1031 exchange, referring to section 1031 in the US Internal Revenue Code. In essence, it is a way of temporarily bypassing capital gains taxes by reinvesting proceeds from a sale into a similar asset.
For example, if a person were to purchase a piece of property for $300,000 US Dollars (USD) in a soft market and sell it a few years later for $500,000 USD, she would make a profit of $200,000 USD. Under normal circumstances, she would be required to pay capital gains taxes on that $200,000 USD. If she were to purchase a new piece of property for $500,000 USD (or more), however, she would be conducting a like kind exchange, and therefore be exempt from capital gains taxes until she made a profit off of the new investment.
The time constraints on conducting this type of deal are somewhat limited, and the Internal Revenue Service (IRS) is traditionally very strict about offering no extensions. For this reason, it is a good idea for people considering it to have a replacement transaction in mind before offering the original asset for sale. Within 45 days of the initial sale, the person must identify the replacement property, and within 180 days of the initial sale, the replacement property transaction must be fully completed. Time limits are calculated in basic calendar days, with no exceptions for weekends or holidays.
Most real property can be subject to a like kind exchange, but stocks, bonds and partnership interests explicitly may not be. Other than that, however, most assets are open. Real estate in the United States is considered like kind with all other real estate in the country, no matter the type or location. For example, a piece of residential property in Louisiana is like kind to a factory in Alaska.
Additionally, property may be involved if it is like class to another piece of property. The IRS recognizes 13 classes of property. A private plane may be used in a like kind exchange with a helicopter, for example, because they are both part of the same transport class. Similarly, a steamroller may be used with a trencher, because both are part of the same construction machinery class.
This type of transaction is an excellent way to avoid capital gains taxes on a transaction if a person's ultimate goal is to reinvest the funds anyway. Because of the time constraints, however, it is important for individuals to contact a qualified intermediary and identify a replacement property as soon as possible.