A 1031 exchange, named after Section 1031 of the U.S. Internal Revenue Code, allows investors to defer paying capital gains taxes on an investment property when it is sold, as long as another “like-kind property” is purchased with the profit gained by the sale of the first property.
In contrast, a Non-Like-Kind Exchange refers to a situation where the properties exchanged are not of the same nature or character. The term “like-kind” is somewhat broad but generally refers to the nature or quality of the property, not its grade or class. Properties are of like-kind if they are of the same nature or character, even if they differ in grade or quality.
In a Non-Like-Kind Exchange, if the properties exchanged are not of the same nature or character, the transaction does not qualify for the tax deferral benefits under Section 1031. This means that capital gains taxes on the property sold would be due in the tax year in which the transaction took place.
An example of a Non-Like-Kind Exchange might include selling a commercial rental property and purchasing a personal residence with the proceeds. Since the properties are not of the same nature or character (investment property vs. personal property), the transaction would not qualify for the 1031 exchange benefits, and capital gains taxes would be owed on the sale of the commercial property.
In summary, a Non-Like-Kind Exchange refers to a transaction involving properties that do not meet the “like-kind” criteria, resulting in the loss of potential tax deferral benefits.