An exchange must satisfy a number of requirements before it can qualify for this tax benefit. Most importantly, the properties involved must be held for investment or for the productive use in a trade or business, such as agriculture. Therefore, an individual cannot use his personal residence for a like-kind exchange. An experienced tax professional can help landowners structure a transaction in such a way to satisfy the tax rules.

A simple example illustrates how a like-kind exchange works in practice. Meet Bob Burger, he bought a house in a suburban development during the recent real estate boom. The problem is Bob doesn’t want to live in the house. He bought it in the hopes that he would be able to sell it down the road for a significant profit. A few years later, the undeveloped farmland next door to his parent’s farm went up for sale. Bob decided that he’d like to follow his father into farming. Rather than selling his property, paying taxes on the sale, and using the remaining funds to purchase the farmland, Bob can exchange his suburban lot for the farmland. While he will have to report the transaction to the IRS Download IRS form, Bob will not owe any taxes until he sells the new property.

Bob can use a like-kind exchange even if the owners of the farm don’t want Bob’s suburban house. The tax rules allow for a neutral party —known as a qualified intermediary (QI) — to purchase property from Bob within certain time limits (45 days for identification and 180 days for exchange)

For example, Bob can sell the house in the suburban development and the proceeds from the sale will go to the QI. Then the intermediary can then use the funds to purchase the farm for Bob.

Landowners can use a like-kind exchange even if the properties are worth different amounts. If, in our example, the farm is worth more than the suburban lot, Bob can exchange the properties and will have to provide the additional money to the intermediary, known as boot, to cover the price difference between the two properties. If Bob’s suburban house is worth more than the farm, the additional money would remain in his intermediary fund to be either used to buy more property or if not used, it would ultimately become boot, and taxable in the eyes of the IRS. While he will defer taxes in the first scenario, Bob will owe some taxes in the second scenario if he doesn't use the extra money for a purchase, although not as much as he would have if he hadn’t done a like-kind exchange.

It is highly recommended that like-kind exchanges be done with a qualified intermediary for several reasons. First, the use of a QI is a safe harbor established by the Treasury Regulations. If the taxpayer meets the requirements of this safe harbor, the IRS will not consider the taxpayer to be in receipt of the funds. The sale proceeds go directly to the QI, who holds them until they are needed to acquire the replacement property. The QI then delivers the funds directly to the closing agent. Second; paperwork, there is a formidable amount for the inexperienced, use a pro. Third; if boot is involved then a QI and an intermediary account will greatly simplify the financial responsibilities. The qualified intermediary industry is largely unregulated, so a landowner should be very careful in choosing a qualified intermediary.