Real Estate Investors – Refinancing With a 1031 Tax Exchange

Written by admin on May 7th, 2011

One of the most essential concepts in the 1031 exchange process is that a property investor must not receive any cash benefit from the proceeds of the sale of his or her relinquished property; any kind of cash benefit from the sale is considered to be boot, and this means, in fact, subject to capital gains taxes. In keeping with this concept, the act of refinancing for the purpose of removing equity from the 1031 property delves into a rather gray area with regard to acceptability under Section 1031.

In a court case involving an investor named Garcia, the court clearly asserted that any benefit received by an investor resultant from the refinancing of a property in anticipation of selling it in an exchange will be deemed to be boot. This decision set a precedent for the way in which these kinds of situations. As of now, a more common strategy is waiting until after the closing on the replacement property, and to refinance at some point afterward. This practice, however, raises the issue of how long it is appropriate to wait before performing this refinancing and removing equity from your replacement property.

The most conservative investors would advise you not to refinance until a considerable time post-closing (maybe as long as two years), in order to make absolutely sure that you’re in compliance with the intent of Section 1031. The popular mindset amongst more liberal minded contingency of investors, however, is to assume that the closing on the purchase of your replacement marks the definitive ending of to the 1031 process, and so an investor need not fret over the substantiation of the exchange from there onward. For a property investor who perceives the 1031 process from this vantage point, it is irrelevant how long one waits to refinance a 1031 replacement property, and many investors will elect to do so directly after the closing .

If you are expecting any kind of hard and fast rule as to when you ought to refinance your replacement property, you are doomed to disappointment, at least in regard to this article. The two schools of thought discussed here are only opinions, and represent extremes on a wide spectrum. Investors vary a good deal in the way in which they elect to approach these types of legal gray areas, and the most useful suggestion that I can {impart is simply to look to qualified tax adviser or legal expert in formulating your final choice, and to work closely with him or her to figure out the approach that will work best in the context of your particular situation.

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