A like kind exchange is also known as a 1031 exchange, referring to section 1031 in the Internal Revenue Code. In essence, a like kind exchange is a way of temporarily bypassing capital gains taxes by reinvesting proceeds from a sale into a similar asset.

For example, if I were to purchase a piece of property for $300,000 in a soft market and sell it a few years later for $500,000, I would be making a profit of $200,000. Under normal circumstances, I would be required to pay capital gains taxes on that $200,000. If I were to purchase a new piece of property for $500,000 (or more), however, I would be conducting a like kind exchange, and therefore exempt from capital gains taxes until I made a profit off of the new investment.

The time constraints on conducting a like kind exchange are somewhat limited, and the IRS is traditionally very strict about offering no extensions. For this reason it is a good idea to have a replacement transaction in mind before offering the original asset for sale. Within 45 days of the initial sale, one must identify the replacement property. Within 180 days of the initial sale, the replacement property transaction must be fully completed. Time limits for a like kind exchange are calculated in basic calendar days, with no exceptions for weekends or holidays.

Most real property can be subject to a like kind exchange. Explicitly, stocks, bonds and partnership interests may not be part of a like kind exchange. 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 United States, 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 used in a like kind exchange if it is like class to another piece of property. The Internal Revenue Service 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 in a like kind exchange with a trencher, because both are part of the same construction machinery class.

A like kind exchange is an excellent way to avoid capital gains taxes on a transaction if your ultimate goal is to reinvest the funds anyway. Don't forget that because of the time constraints, it is important to contact a qualified intermediary and identify a replacement property as soon as possible.