Like-Kind Exchanges Are Essential to Long-Term Real Estate Investments

This blog post was written by George Ratiu, Director of Quantitative & Commercial Research and Erin Fitzpatrick, Research Intern.

Real estate constitutes the foundation of economic activity, with real estate transactions providing the connecting pathways between individuals, businesses, and governments. In 2014 the value of real estate in the United States totaled $42.4 trillion[1]. Sales of commercial real estate assets—priced at or above $2.5 million—totaled $438 billion[2] in 2014, while sales of smaller commercial assets—priced below $2.5 million—comprised an additional $60 billion[3]. In addition, sales of residential real estate totaled $1.1 trillion[4] in 2014, with existing properties accounting for 89 percent of total.

For a significant proportion of real estate market participants, like-kind exchanges (LKE) provide an important vehicle to sell and acquire property. The Internal Revenue Code (IRC) Section 1031 codifies that the tax owed on any gain after a sale may be deferred as long as the proceeds are reinvested in a similar property through a like-kind exchange.  The Internal Revenue Service (IRS) makes note of the fact that while the gain “is tax-deferred […] it is not tax-free.”[5]

According to the IRS, “like kind property is property of the same nature, character or class. […] Most real estate will be like-kind to other real estate.”[6] Generally, a parcel of land with a rental house may be exchanged for vacant land. Similarly, an office building may be exchanged for an industrial warehouse or a retail shopping center.

Like-kind exchanges (LKE) feature prominently in NAR members’ real estate transactions. The Like-Kind Exchanges: Real Estate Market Perspectives 2015 report details the long-term nature of real estate investments transacted as LKEs. Based on the data, 47 percent of respondents reported their holding period was between 5-9 years, followed by 27 percent who indicated a holding period of 10-14 years.

personal propertyBased on specialty category breakdowns, there were two slight differences in holding periods between commercial and residential members. About 8 percent of commercial members reported that they or their clients hold property for a short term, 0 – 4 years. Close to double that proportion—15 percent—of residential members reported a similar holding period.  For the holding period choice of 5 – 9 years, 48 percent of commercial members responded affirmatively compared with 43 percent of residential members.The importance of like-kind exchanges for real estate was underscored by member responses to the issue of a potential repeal of LKEs. Repeal of the IRC Section 1031 provision would likely increase holding periods. Five times as many respondents (49%) said that the holding period would be greater than 50% of useful life compared to those that said there would be no change (9%). An additional 34 percent of members pointed to an increase in holding periods by 20 – 50 percent of a property’s useful life.  The responses highlighted that repealing section 1031 would likely decrease the frequency of dispositions in the market.

impactTo access the Like-Kind Exchanges: Real Estate Market Perspectives 2015 report, visit http://www.realtor.org/reports/like-kind-exchange-survey.


[1] Federal Reserve Board, Flow of Funds B.101, B103, B104 tables

[2] Real Capital Analytics, US Capital Trends®

[3] Smith and Ratiu (2015), “Small Commercial Real Estate Market,” National Association of REALTORS®

[4] U.S. Census Bureau, New Residential Sales; National Association of REALTORS® Existing Home Sales

[5] Internal Revenue Service, Like-Kind Exchanges Under IRC Code Section 1031, FS-2008-18, February 2008

[6] Ibid.

George Ratiu, Director, Quantitative and Commercial Research

George Ratiu, Research Economist, writes regular economic columns and conducts research in the areas of commercial real estate, international investments, mortgage performance and foreclosures. He produces NAR’s Commercial Real Estate Outlook and manages quantitative surveys, including the Commercial Real Estate Quarterly Market Survey.

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