When Is It Safe To Remove Equity From a 1031 Property?

One of the most essential concepts in the process of a 1031 exchange is that an investor cannot receive any cash benefit from the proceeds of the sale of his or her 1031 property; any kind of cash benefit from the sale is considered to be 'boot', and what this means is that it is, in fact, subject to capital gains taxes. In keeping with this concept, refinancing in order to remove stored value from the replacement property enters into a rather gray area with regard to compliance with Section 1031.

In a case brought against an investor by the name of Garcia, the court asserted that any benefit gained by a taxpayer as a result of the refinance of a property in advance of selling it in an exchange will be deemed to be boot. This court decision represented the establishment of a standard for the manner in which these sorts of issues. As of now, a more common strategy is waiting until the replacement property has been closed on, and to refinance at some point afterward. This strategy, however, raises the issue of how long it is appropriate to wait before refinance and removing value from your replacement property.

The most conservative investors will tell you that you should wait a considerable period of time post-closing (maybe even two years), in order to make absolutely sure you are complying with the intent of Section 1031. The current trend amongst the more liberal minded school of real estate investors, however, is to make the assumption that closing on your replacement represents a definitive end to the exchange process, and that one does not need to worry about the substantiation of the exchange after this point. To an investor who perceives the 1031 process from this vantage point, it is not relevant how long one waits before refinancing a 1031 replacement property, and many will elect to do so directly after the closing .

If you're expecting any definitive rule as to when you ought to refinance your 1031 replacement property, then you are destined to be disappointed, at least within the confines of this short article. The 2 perspectives discussed above are only opinions, and are examples of extremes on a wide spectrum. Real estate investors vary greatly when it comes to how they elect to look at these types of legally gray areas, and the best advice I am able to {impart is simply to look to good tax adviser or legal expert in making your final choice, and to work together with him in order to decide on the path that will be most effective in the context of your particular case.

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