Refinancing With a 1031 Tax Exchange

One of the key concepts in the 1031 exchange process is that an investor must not draw any cash benefit from the funds resulting from the sale of his or her relinquished property; any kind of monetary benefit from the sale is considered to be boot, and this means, in fact, liable for capital gains taxes. In keeping with this logic, refinancing for the purpose of removing stored value from the 1031 replacement property delves into a rather gray area with regard to acceptability under Section 1031.

In a case involving an investor named Garcia, the court clearly asserted that any benefit gained by an investor resultant from the refinancing of a property in anticipation of selling it in a 1031 tax exchange will be considered to be boot. This court decision set a precedent for dealing with these kinds of situations . Currently, a more popular tactic is waiting until the replacement property has been closed on, and to refinance the piece of property at some point later. This tactic, however, raises some questions about how long it is appropriate to wait before performing this refinancing and removing equity from a property.

The old guard among real estate investors will advise you that you should wait a considerable period of time post-closing (perhaps two years), to make absolutely sure that you’re complying with the intent of 1031 tax exchanges. The popular mindset amongst more liberal minded contingency of real estate investors, however, is to assume that the closing on a replacement property marks the definitive ending point of to the exchange process, and that one need not fret over the substantiation of the exchange from there onward. For a property investor who looks at the exchange process from this perspective, it is not relevant how long one waits before refinancing one’s 1031 replacement property, and many do indeed elect to do this immediately after the closing has occurred.

If you are looking for any kind of hard and fast maxim as to when it is safe to refinance a 1031 replacement property, then you are destined to be disappointed, at least within the confines of this short article. The two schools of thought described in this article are just the opinions of a few, and they are examples of only a few of the viewpoints an investor may adopt. Property investors vary greatly when it comes to the way in which they elect to look at these sorts of gray areas, and the wisest suggestion I can {give you is simply to enlist the help of a qualified tax adviser or other legal expert in making your ultimate decision, and to work together with him or her so that you can decide on the approach that will work best in the context of your particular situation.

A profitable option is to conduct a 1031 tax exchange…

As a player in the real estate game, you must be aware that dollar that you have working for you is compounding your wealth, and, conversely, that every dollar not working for you can be considered a missed chance to further compound your profits. So, when it comes time to put your property up for sale pay capital gains taxes . Every time you pay money to the U.S. government you are throwing away potential profits.

The second and more profitable option is to conduct a 1031 tax exchange. A great way to keep more of your investment funds making you more money is to perform a 1031 tax exchange rather than making an outright sale. A 1031 exchange has a non-recognition provision; this means that you aren’t obligated to pay the taxes immediately following your sale; as a matter of fact, your capital gains liability are deferred for an indeterminate time span, while your funds are compounded by the extra income produced by investing your tax deferment.

To demonstrate, let’s say that you own some small investment properties, like triplexes or duplexes, whose values have increased over time. At this point, your first inclination may be to sell these properties and collect on your investments. But a wise investor with an eye to the future might decide to conduct an exchange and place the money gained from these investment properties towards the purchase of another piece of property, which will, itself proceed to appreciate in value over time and continue to compound your wealth. Best of all, the money available to you as a result of deferring capital gains taxes will function to heighten your ability to leverage for greater loans, maximizing your potential profits.

1031 exchanges are not limited to just buildings and land, either. It is possible to conduct a 1031 exchange on any real estate held for investment in a business or trade, as well as certain types of personal property, from cranes or backhoes to an aircraft or collector car. 1031 exchanges are especially advantageous for those who have money in antiques or collectibles such as collector cars, in light greater capital gains liability on the sale of these types of items. You cannot, however, exchange things like stock, bonds, or interest in an REIT.

So, next time you are in the position to sell a piece of real estate or other investment, pause for a moment and consider the profit you could reap were you to conduct an exchange instead. If you decide to conduct a 1031 exchange instead of selling outright, you can maximize your wealth and come out ahead.