Real Estate Investors - Refinancing With A 1031 Tax Exchange

By Author: Trisha Coppley
Total Articles: 46
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One of the central concepts behind the 1031 exchange process is that a real estate investor is not allowed to receive any direct benefit from the funds gained as the result of the sale of a 1031 property; any money removed from the sale is seen as 'boot', and this means liable for capital gains taxes. As a result of this, refinancing in order to remove stored value from the 1031 replacement property delves into a rather gray area with regard to acceptability under Section 1031.

In a court case brought against an investor by the name of Garcia, the court ruled that all benefit gained by a taxpayer resultant from the refinance of a piece of real estate in advance of relinquishing it for an exchange will be considered to be taxable boot. This court decision represented the establishment of a standard for the manner in which these sorts of issues. As of now, a more popular strategy is waiting until the replacement property has been closed on, and to refinance at some point afterward. This tactic, however, raises the question of how long it is appropriate to wait before performing this refinance and taking equity ...
... from a replacement property.

The most conservative investors would advise you that you should wait a considerable period of time post-closing (perhaps even as long as two years after), ensure that you are in compliance with the implicit meaning of Section 1031. The current trend amongst the more liberal-minded school of property investors, however, is to make the assumption that the closing on the purchase of a replacement represents the definitive ending point of to the 1031 process, and that one does not need to fret over the substantiation of the exchange after this point. For a real estate investor who looks at the exchange process from this vantage point, it is not relevant how long one waits to refinance a 1031 replacement property, and many will elect to do this directly after the closing has occurred.

If you are expecting any sort of definitive rule as to when you ought to refinance a 1031 replacement property, then you are destined to be disappointed, at least in regard to this article. The 2 perspectives that I have described in this article are merely the opinions of a few, and they are examples of only a few of the viewpoints an investor adopt. Investors vary greatly in how they elect to look at these types of legal gray areas, and the most helpful advice that I can {give you is simply to consult with a good tax adviser or other legal expert in making your final decision, and to work together with him so that you can decide on the path that will be most effective in light of your specific situation.