The IRS defines "like-kind" property remarkably broadly when it comes to real estate exchanges. At its core, the requirement simply means that you must exchange real estate for real estate, but the similarities can end there. The tax code focuses on the fundamental nature of the property (that it's real estate) rather than its specific class, quality, or use.

This flexibility creates tremendous opportunities for investors. For instance, you could exchange a small apartment building in New York for farmland in Kansas, or a single-family rental home for a strip mall. The properties don't need to be of similar value, size, or even development status—you can exchange improved property for raw land or vice versa.

The tax code recognizes a wide variety of real property interests as eligible for like-kind exchanges. These include: 

• Traditional real estate holdings like commercial properties, multi-family rentals, and single-family homes 
• Land-based investments such as farms, ranches, and vacant lots 
• Short-term rental properties like vacation homes used for Airbnb or VRBO 
• More specialized interests including water rights, mineral rights, and oil and gas interests 
• Infrastructure-related rights such as cell tower easements, billboard rights, and fiber optic cable easements 
• Conservation easements 
• Delaware Statutory Trusts (DSTs)

However, there is one crucial geographic restriction: properties must be located within the same country. 

The IRS recognizes only two distinct geographic zones for 1031 exchanges: 

domestic (within the United States) 

foreign (outside the United States)

This means you can't exchange a property in Ohio for one in Peru—U.S. properties must be exchanged for other U.S. properties, and foreign properties must be exchanged for other foreign properties.

Think of it this way: when it comes to real estate exchanges, the IRS cares more about what category of asset you're investing in (real property) than the specific form that property takes. This flexibility allows investors to shift their real estate strategy while maintaining their investment in the broader real estate market.

Understanding Selling Expenses in a 1031 Exchange 

When you sell an investment property as part of a 1031 exchange, it's crucial to understand which closing costs can be paid from your exchange funds without triggering a taxable event. Think of it as two categories of expenses: those that are directly related to the real estate transaction itself (which are generally allowable) and those that are related to operating the property (which typically trigger taxes).

Allowable closing expenses that won't create a tax liability include: 

• Transaction-related costs such as real estate commissions and finder's fees 
• Title insurance premiums for the owner's policy 
• Professional fees (attorneys and tax advisors) specifically related to the property transaction 
• Essential closing costs like title company fees, escrow charges, and recording fees 
• Documentary stamps and transfer taxes

However, operating expenses paid from exchange funds will generate a tax liability. These include: 

• Rental income adjustments (pro-rated rents) 
• Security deposit transfers 
• Ongoing property expenses like utilities and insurance 
• Property tax prorations 
• Homeowner association dues 
• Property maintenance and repair costs 
• Loan-related charges

Refinancing Strategies

Timing is Everything Many investors wonder about accessing their equity through refinancing while still maintaining the tax benefits of a 1031 exchange. The timing of refinancing is critical. While it might seem tempting to refinance just before an exchange to pull out cash, the IRS generally views this unfavorably, seeing it as a way to circumvent exchange rules by accessing what would otherwise be exchange funds.

However, there are two legitimate approaches to refinancing:

1. Well in Advance: If you need to refinance your relinquished property, do it well before contemplating an exchange. The more time between the refinance and the exchange, the better. The IRS looks more favorably on refinancing done for legitimate business purposes, such as:
   • Addressing cash flow needs
   • Funding necessary property improvements
   • Meeting other business obligations
2. Post-Exchange Refinancing: The safer approach is to complete your exchange first, then refinance the replacement property. The American Bar Association's Section on Taxation has confirmed that once you own the replacement property, you're free to refinance it just like any other property owner. This approach keeps the exchange transaction clean while still allowing you to access equity after the fact.

Seller Financing in 1031 Exchanges 

Seller financing can be compatible with a 1031 exchange, but it requires careful structuring. When you provide seller financing, you're essentially creating two assets: the real estate being sold and a promissory note from the buyer. Since the note isn't like-kind property, you'll need to handle it carefully to maintain exchange eligibility.

Here are the main approaches:

1. Early Note Resolution: If the buyer can obtain traditional financing before you need to complete your replacement property purchase, the note can simply be paid off and the funds added to your exchange account.
2. Note Buyout Strategy: If the buyer won't have traditional financing in time, you can perform a "note buyout." This involves:
   • Contributing your own funds to the exchange account to "purchase" the note from yourself
   • Using personal funds or a separate loan to facilitate this buyout
   • Maintaining the right to receive future payments from the note

The key to success with seller financing is timing: ideally, you want to receive any cash into the exchange account before purchasing the replacement property, while waiting to formally assign the note until after completing the replacement property acquisition.